Managing a Temporary Cash Crunch

Income shortages come in many ways. Some of them are long-term because of insufficient education, limited opportunities near home, or other reasons. Other income shortages are temporary in nature. Temporary income shortages happen for reasons such as a short-term lay-off, a health situation, or a temporary spike in expenses.

Here are several ways to manage a short-term cash crunch.

1. Emergency funds. Savings exist for short term income shortages. If you don’t already have an emergency fund, now is a good time to start. Start by saving $1,000 then build toward three to six months income.
2. Sell something. I recently spent time in our basement looking at things we no longer use. We have a crib and cradle we won’t use for a long time. They’re both in great shape, so we’ve considered keeping them for our grandkids. We’re not really attached to them though. If we were in a cash crunch, I’d use eBay, Craig’s List, a garage sale, or other mechanism to sell them.
3. Garage sale. My mom and her friends used to have a garage sale every spring. They’d sell books, clothes, furniture and baked goods. A garage sale can easily earn a few hundred dollars if you put up some fliers or posters beforehand.
4. Flip burgers. What I really mean is get a second job. Second jobs should be low stress, fairly mindless, and never interfere with your real job. Most people can’t sustain two jobs for an extended period of time, but if you’re looking to get through something temporary it is a great way to make a few hundred dollars a month.
5. Cut optional expenses. As we’ve talked about before, we’ve all got optional expenses. Some optional expenses can be cut or reduced easily. Sometimes you can trim an expense without actually cutting any service, like our cable bill.
6. Barter. Do you have a skill or time you could exchange for services you typically pay for? One of our readers, Broc K, recently shared how his wife offered to babysit in exchange for free music lessons for their girls.
7. Turn a hobby into a business. Are you a pianist? Piano lessons can fetch $10-20 per lesson. Growing up, my Dad broke colts for others and later taught me to use the same skill to earn a few hundred dollars a month. Most of us have a skill or hobby that could generate a bit of extra cash flow—use it.

How have you managed short-term income shortages?

Habits that Break the Bank

My kids have recently been on an anti-smoking campaign. When they see someone smoking on the street or in the car next to us the tell them something along the lines of "...if you smoke, you're going to die." My kids are young, so I'm ok with the directness of their message.

One day after they'd so tactfully told a stranger how smoking was going to kill them I got thinking about another big reason to not smoke. Smoking is an enormous budget killer.

I haven't been in the market for a pack of cigarettes for a long time, so did a little research. The cost of a pack of cigarettes in Utah is about $4.50. I had a tough time figuring out the average number of cigarettes someone smokes in a day, but found smokers posting online who said anywhere from 10-40. A pack a day (20) seemed to be a very common answer.

During my reading I ran across a forum on http://www.cigreviews.com/ talking about how much people are paying for cigarettes. My favorite quote from the forum is below.

"Sad as it is, I never buy cartons. I never have the damn money. I've bought them once or twice and I think they were about 40 bucks, but as far as packs go here they're about 4 and some change depending on what you buy."

Irony perhaps? Someone who smokes a pack of cigarettes a day is spending $135 per month on cigarettes. Imagine an extra $135 going into your retirement account each month. If someone took their $135 smoking habit and redirected it to retirement they'd have $201,000 in 30 years (assuming an 8-percent return on their investment).

A friend of mine who's wife quit smoking a year ago has been able to increase monthly savings by $500 per month just from not spending on cigarettes. She was a heavy smoker, but even for an average smoker the savings are great.

The costs of smoking aren't just the cigarettes themselves. Health care costs more, you age faster, your clothes wear out faster, your vehicles depreciate faster, etc. Smoking has many hidden costs. As you can see, even ignoring the hidden costs you'll end up far wealthier by not smoking than by smoking.

NOTE: My intent isn't to indict smoking, just to raise awareness about the long-term financial impact of seemingly small things. A cup of coffee from starbucks each day accomplishes the same thing.

Stop Reading and Sign-up

This post is for all of the soon to be college graduates and those who are starting a new job. On your first day at your new job you'll spend time filling out all sorts of paperwork. The most important one is probably your W-4, which your employer needs to pay you. The second most important? Some people might say your insurance forms, I'll go with signing up for your company 401k.

You can contribute up to $16,500 per year to your company 401k. Most employers also match your contributions to some degree. The average company contributes $0.50 for every $1.00 you contribute up to 6% of your income. Simply said, they're giving you a tax deferred (you don't pay taxes on it until retirement) 3% raise. Most financial advisors call the company match "Free Money".

Free money is one of the biggest reasons to sign up for your 401k on your first day on the job. Another big reason is that the earlier you save, the easier building wealth becomes.

Someone who contributes $2,000 per year to their 401k from 20-30 then leaves it alone to grow until they're 60 will have nearly $291,000 to help fund retirement. This person will only have saved $20,000 of their own money. All of the rest of the wealth will have grown from an 8-percent annual growth rate.

Someone who waits until they turn 30 to start saving can still save the same $291,000. However, they have to save a lot more and a lot longer. The 30 year old will have to save $2,600 per year from 30 to 60 at an 8-percent growth rate. The person who waited will have to save a total of $78,000. They'll still get most of their money from compound interest, but it'll be a lot more work.

All of you college graduates, start now. If you think you can save $5,000 per year, stretch to $6,000. If your employer is matching another $1,500 you'll have $7,500 per year going into your retirement plan. Using the same 8-percent return and saving that same $7,500 for 30 years, you'll have $850,000. Now we're building wealth!

If your employer has a 401k with a match, go sign up. Stop reading this post right now to go sign up. You'll start building wealth today!

Five Ways to Pay for College, If You Haven't Saved

Today's post is the final post of our series on saving for college. If you've missed the earlier posts, here they are.

• Ten things to do before saving for college
• Retire First, College Later
• Reasons to Save and Not to Save for College
• 529 Plans Debunked
• Five ways to pay for college if you haven't saved

Five Ways to Pay for College if You Haven't Saved

If your child is headed off to college this fall and you haven't saved, you still have several options. Each of these individually may not fund their entire education, but when used in conjunction are likely to get your child the education she needs to set out on an independent and successful life.

Apply for a federal grant. The difference between a grant and a loan, is you don't have to repay the grant. The US Government has several types of grants. The most common is a Pell Grant. The maximum amount for the 2009-10 school year is $5,550, which can make a big dent in tuition, fees, and books. If you are a Pell Grant recipient, you may also qualify for an Academic Competitiveness Grant, which adds another $750 to $1,300. You can read about and apply for grants on the Department of Education's site.

Get a summer job. Have your child get a job. They probably won't be able to save the entire amount, but a summer of $8 / hour will net around $3,000. You might even work out a deal where you match their savings to motivate them to save as much as possible.

Maximize then use your tax return for tuition. Once your child is in college, you or she will likely qualify for some tax advantages. The tax programs include the Hope and Lifetime Learning credits as well as some deductions. If your income is too high for one of the credits, you can probably still deduct tuition payments to reduce your tax bill. Use all or some of the credits and deductions to funnel money toward college. The IRS website gives more information about tax benefits of college.

Apply for a loan. A few options exist for borrowing for college. The federal government administers student loan programs that meet most student's needs. The biggest difference between the government's loans and grants is loans must be repaid. Available loans range from subsidized student loans to Plus loans where the parent is the person responsible for repayment. You apply for a federal loan using the same form as your Pell Grant. Some of the loans even have deferral options so you don't have to repay until your child is finished with college. You can read more about the options on the Department of Education's site.

Reduce college expenses. Reducing the tuition and fees for your child may be difficult if they are working toward a specialized degree. You can save a lot on college expenses though. Have your child live at home during college. Most areas of our country now provide access to remote learning where your young adult could take classes via the internet to get through their general education.

Another option for reducing expenses is to attend a cheaper school. In Utah, most kids want to attend the U of U or BYU. They are also two of the most expensive schools in Utah. A great way to get a degree from a top school and keep your expenses down is to attend a community college or smaller university for the first couple years. If you pursue this route, make sure credits will transfer to the school you plan to get your degree from.

It Is Achievable!

As you can see, if you're headed to college or have a child headed to college you can go even if you haven't saved. I know plenty of people who headed to college with little or no savings. They had a lot of encouragement and support from parents, were committed to getting an education, and found ways to leverage all of the options above to get through school. So can you!

Saving for College: 529 Plans Debunked

Today's post is a continuation on our college savings series. If you've missed the earlier posts, here they are.

• Ten things to do before saving for college
• Retire First, College Later
• Reasons to Save and Not to Save for College
• 529 Plans Debunked
• Five ways to pay for college if you haven't saved

529 Plans Debunked

The options for college saving are nearly as broad as opinions on the topic. The federal government and most state governments have made it easier for us to save now than in the past. One of the best options for college savings is the 529 plan.

529 plans are a relatively new savings option. They were introduced in 1996 and are named after the section of the internal revenue code which created the plans. They basically come in two forms.

1. Savings plan where you put money into the plan and choose an investment. Growth of your savings is based on the performance of your investment choices. Investment choices are simple, so you don't have to know how a lot to choose.
2. Prepaid plans allow you to purchase tuition credits at current tuition rates. The performance of your investment matches annual tuition increases.

529 plans are administered by each state. Every state now has at least one 529 plan. The plans vary widely from state to state. The variations include investment options, expenses, and tax deductibility of contributions.

The benefits of a 529 plan include:

• High contribution limits. You can contribute $300,000 plus per beneficiary, depending on the state plan you choose. All states are at least $300,000.
• Contributions and earnings remain owned and controlled by the 529 account owner.
• Contributions are tax deductable on state income taxes in many states.
• Money not used by the beneficiary can be transferred to other beneficiaries. For example, you could transfer leftover money from an older child to a younger sibling. You could save your investment beyond your kids and transfer it to a grandchild if you'd like.
• Any growth of your investment comes out federal tax free if used for a qualifying college expense.
• Investments are simple. In most state plans you choose a year your child will start college and the fund manager makes the investment more conservative each year. Your investment will move from highly stock based when your child is young to mostly bond and cash based as she gets close to going to college. You don't have to think about it.
• Limited impact on financial aid eligibility. 529 plan assets owned by a parent are listed as parental assets. Therefore, they have a minimal impact on eligibility for financial aid.
• You can continue contributing to a 529 beyond a beneficiary's 18th birthday.
• Tuition rates in many states are climbing 7-10 percent per year, which is a great return. If you are confident your child will attend a state university, this makes the prepaid plan a good option.

Disadvantages of 529 Plans

• Any withdrawal for non-college expenses will be taxed as regular income and assessed a 10-percent penalty.
• Funds not use for college are stuck in the plan unless you choose to pay taxes and a penalty.
• Account owner can only make changes to investments once per year. I don't consider this a disadvantage, but some of you might.
• Fund expenses (amount charged by the 529 plan manager) are higher than normal mutual funds. If your child is within a couple years of college, this is a big reason to not go with a 529.
• Prepaid tuition plans lock you into state owned universities and colleges.

If you choose a 529 as a college savings vehicle, you aren't locked into your state's plan. If your state doesn't offer an income tax deduction, then you should look at other plans. Utah's plan does offer a deduction and has among the lowest expenses, so I've chose to save in our plan.

Reasons to Save and Not to Save for College

Today's post is the third of our saving for college series. If you've missed any of the previous posts, here they are.

• Ten things to do before saving for college
• Retire First, College Later
• Reasons to Save and Not to Save for College
• 529 Plans Debunked
• Five ways to pay for college if you haven't saved

Reasons to Save and Not to Save for College

Saving for college is a very personal thing. It is tied closely to the goals you've set for yourself and the goals of your kids. With that in mind, here are a few reasons to save and a few reasons not to save for your kids' educations.

Four Reasons to Save for College

1. The median income for someone with a bachelor's degree is double that of someone with only a high school diplima. A recent study also found that the unemployment rate for those with a bachelor's degree is 1/3 that of those with only a high school diploma.
2. Happiness has a highly positive correlation to level of education. Studies have shown that those with graduate degrees tend to rate themselves happier than those who have limited or no college education.
3. Some kids need roadblocks removed to help them go to school. A friend of mine has a son who is very motivated and would have gone to school without help. He has another son who has very little scholastic motivation and needs the extra push. He chose to pay more for the second son to remove a reason / excuse not to attend college.
4. You have a goal to help your kids get an education. Some people value education enough to put it on their life goals list. I have a goal to help all four of our kids get a bachelor's degree. The help we'll offer will range from giving them the opportunity to live at home during college to a lot of encouragement and some tuition assistance. The motive is to help my kids have an education that creates options during their life and to limit need for ongoing economic help as adults.

Four Reasons Not to Save for College

1. You can't borrow for retirement, your kids can borrow for education. Saving for education over retirement is fiscally irresponsible. Your kids will end up helping you in retirement, which may set them back more than paying for their own education.
2. Your kids might appreciate their education more if they earn it themselves. My parents encouraged college from when I was very young. They always talked about where, not if I would go to college. They expected me to earn it and I value it deeply because I worked for it.
3. You can't predict how much your kids will need for education. They may earn scholarships or qualify for grants. Most college savings plans penalize withdrawals that are not for qualified educational expenses.
4. You might be in a position to pay as you go when your kids start college. Your income may have risen or you may be completely out of debt. If this is your preferred approach, then make sure you're working a plan to get there.

What are some of the reasons you have or haven't chosen to save for college?

Retire First, College Later

Today's post is part of our series on saving for your children's education. The topics we'll be covering are:

• Ten things to do before saving for college
• Retire First, College Later
• Reasons to Save and Not to Save for College
• 529 Plans Debunked
• Five ways to pay for college if you haven't saved

Retire First, College Later

We were recently out with some friends of ours and had a discussion about when to save for our kids' education. Some people start saving for college when their child is in the womb or earlier. In some cases that's a good plan, in others its not. My approach is to focus on our retirement needs before funding education for kids. We won't have access to loans in retirement. Our kids will be able to get a loan for school.

The question I ask myself before saving for college is whether we have saved enough to survive in retirement given a conservative growth rate? To answer this question, we turn to time value of money again. The financial calculator we've used in the past can help us decide if our current retirement savings will grow to enough to "get by" in retirement.

Plug the following information in the calculator.

1. Present Value (PV) = everything currently in your retirement accounts.
2. Rate (i)= a conservative number like 5 or 6-percent per year (this is the percentage you expect your savings to grow at)
3. Payment (PMT) = However much you are contributing to your retirement per year
4. Periods (n) = Number of years until retirement. We're trying to estimate a conservative worst case scenario here. In my case, I used 38 since that's when I'll be 70. Seventy seems like an old retirement age, but we're being conservative.
5. Future Value (FV) = blank (we're solving for this variable)
6. Click on "FV". The number in the FV field is how much your savings will grow to by the time you retire. It will show as a negative number, which is fine at this stage.

Knowing your total savings is a key step. Now you should determine if that savings will create enough annual income to survive.

1. Copy the FV amount into the PV field.
2. Leave Rate alone since it's a conservative number.
3. Change Periods to the number of years you expect to survive in retirement. My family has a history of passing in their 70s and a history of living into their 90s. We're being conservative, so I expect to live to 100.
4. Click on the PMT button.
5. You now know how much your current savings could give you in savings each year of retirement.

If you're close, but not quite there, play with the calculator. Insert a bigger payment (savings) amount you could continue saving while saving for college while doing the first calculation above. Could you shrink your current annual savings enough to start a college savings fund and still make your survival retirement goal?

If you've saved enough to achieve your "getting by" retirement, then take a look at "Ten Things to do Before Saving for College" as a guide to see if you're ready to start focusing on college.

Saving for College: Ten Things to do Before Saving for Your Kids' Education

I've had numerous debates over the years about saving for college. Some people think their kids will value their education more if they earn it. Others plan to pay for their kids education, no matter what. The opinions vary widely, so this week I'm going to focus on things to consider in relation to saving for your kids' education.

Today is the first of a series of posts that will show up over the next several days.

• Ten Things to do Before Saving for Your Kids' Education
• Retire First, College Later
• Reasons to Save and Not to Save for College
• 529 Plans Debunked
• Five ways to pay for college if you haven't saved

Ten Things to do Before Saving for College

1. Pay for your own education, including paying off all student loans.
2. Get a handle on your cash flow, as we discussed in this earlier post.
3. Get your career established and stable.
4. Pay off all of your consumer debt and keep it paid off for two years.
5. Pay off your cars.
6. Consistently save 10% of your gross income in a retirement account for three years and be sure you can continue while you contribute to your kids' educations.
7. Have enough in your retirement account to fund a "get by" retirement (more detail on this will come on Tuesday)
8. Have an emergency fund with three months living expenses.
9. Own a home with at least 25% equity. You might even want to stretch to 50% equity before saving for college.
10. Figure out your college contribution goals.

Not all of these apply to everyone and some of us will need to focus on other things before saving for college. What are some of the things you advise to do before saving for college?

The Real Cost of Credit Cards

This post is a follow-on to Monday's post about time value of money. Credit cards can be great tools for managing cash flow or keeping track of expenses. I use mine for nearly 100-percent of my monthly expenses then pay it off in full at the end of each month.

Sometimes a credit card can be a temptation. Christmas and vacations are times many of us are lured into spending beyond our budget. We put it on the card then start the long, arduous process of paying it off.

One of the reasons we're so easily tempted is we're only looking at the price tag of the item we're buying. We don't look at the amount the item will actually cost us after we pay off our card.

As I mentioned on Monday, time value of money means a dollar today is worth more than a dollar tomorrow. Credit card companies are betting on us not knowing TVM. They hope we'll borrow a dollar from them today then pay it plus many other dollars of interest back in the future. They require extremely low monthly payments, so the amount of interest paid to them is maximized.

Mastercard has advertisements that say, "Disneyland tickets: $2,000. Meal at Disneyland: $120. Disneyland hotel: $600. A picture of your daughter with Goofy: priceless."

If you pay off your Mastercard at the end of the trip, the total price of that picture is $2,720. If you decide to pay the minimum monthly payment on that $2,720, the price of the picture is $5,685--An enormous hit to wealth building!

NOTE: My assumptions for this calculation are a $50 monthly minimum and 18% APR. Both of which are in line with many credit cards.

New laws require credit card companies to share information about how much interest you'll pay and how long you'll pay the minimum to get your card paid in full. Nonetheless, they want you to not know about time value of money. They are betting on you not knowing the picture will cost nearly $3,000 in interest.

If you're making a credit card payment, I'd encourage you to jump over to the financial calculator from the other day and run through your scenario. Enter the amount you currently owe (present value), your interest rate, your monthly payment (enter this as a negative number), and click on Periods. Multiply your monthly payment by the number of periods and you'll see the total amount you'll pay to get the card paid off.

Is there some way you could accelerate payoff to minimize the interest paid? Could you sell something? Do you have an optional expense that could be cut and applied to your credit card? If nothing else, can you start by not using the card any more?

NOTE: I just noticed today that you don't have to figure out what your monthly interest rate is. This calculator will do it for you. In the drop down box that says "Annual" choose monthly.

Time Value of Money

I've been cautious about being overly technical in my posts, so far. For the most part I'll hold true to that approach. However, today I'm going to introduce the most important technical concept we need to build wealth, time value of money (TVM). Those who understand it build wealth.

Today's post is a primer I will refer back to in future posts. We'll use it for a variety of things like calculating a mortgage payment, calculating the cost of paying interest on a credit card, determining how much we'll save over a period of years, and many other things.

The importance of TVM for each of us is related to our borrowing, saving, and investing money. Basically, $1.00 today is worth more than $1.00 in the future.

The TVM is the value of money given an interest rate and an amount of time.

A simple example of time value of money is you save $1 today for one year, at 6% interest, and you'll receive $1.06 one year from today. $1.00 of what you get back was yours already and the bank paid you $0.06 to borrow your money for a year.

NOTE: If you put this example into a financial calculator, the answer to your future value will be $-1.06. The reason it will show negative is at the beginning of the year you gave money to the bank, at the end they gave it back. The negative number denotes one of the cash flows is away from you while the other is to you.

Time value of money has five variables, one of which you'll solve for each time you use this tool.

1. Present Value (PV) is the value of a future stream of income today. If you have $100 in the bank right now, the present value is $100. If you need $100,000 in 20 years, you could calculate how much (the PV) you would need today for it to grow to $100,000 over 20 years.
2. Rate (i) is the percentage you will pay to use someone else's money in a loan. Even better, rate is the percentage someone else will pay you to use your money. The symbol for Rate is i because rate means Interest Rate. Most rates are published as annual percentage rates. If you are calculating the present value of a set of monthly payments you should divide the APR by 12, an annual payment you would use the APR, etc. Make sure you are using the APR or interest rate and not the annual percentage yield (APY). I'll cover the difference in a future post. For now, use the APR.
3. Periods (n) is the number of years, months, etc you will leave your money in an investment or will receive / make a payment. A 30 year mortgage has 360 (30 years x 12 months) periods or payments.
4. Future Value (FV) is the value of today's investment after it has grown from interest or your additional investments. We'll use future value calculations to determine the size of your nest egg when you retire.
5. Payment (PMT) is the payment you'll make or amount you'll save per period.

The primary TVM formula is below. As you can imagine, there are dozens of derivatives. I give this to you as a reference only. Don't don't worry about studying it. The most important thing to understand is that the formula is the same whether you are borrowing or saving money. You'll use the same calculator in either case.

If you're a math lover, have a blast. As much as I like math, I prefer a financial calculator to solve for any of the five variables. If you don't own financial calculator (not the same as a scientific calculator), here is a free online one.

Understanding time value of money is critical to building wealth. I'd suggest using the calculator above to run through a couple of your scenarios. It'll help this concept resonate better.

I've run through a sample auto loan below. As you can see, the PV is the amount borrowed. The Rate is the monthly interest paid. I've used an annual percentage of 6%, which makes .5% per month. The number of periods (n) is the number of months my loan is for. FV is zero since when I finish the 60 months, I won't owe anything to the bank. Then I clicked on PMT to calculate my monthly payment. As you can see, it's negative to denote I'm paying the bank.

TVM of money is a somewhat difficult concept, but it's a critical thing to understand to help you build wealth. I know this post reads like a text book, so if you have questions post them. We'll work through them together.

Cash Flow: Diversifying Income

Diversifying our investments is advice nearly every financial adviser gives their clients. "Don't put all of your eggs in one basket", they'll say. Most of us follow this advice by investing in a mutual fund or a variety of mutual funds.

Career advisers don't tend to give the same advice, yet it is just as important of a principle. Very few of us diversify our income very much and risk losing our income stream with a single job loss.

Who needs to diversify their income?

The short answer is we all do. Diversifying income becomes less important as you near being independently wealthy. That only applies to a small set of our population though. If you're dependent on your current income to live, look around for ways to introduce variety into your income.

How can we diversify income?

Turn a hobby into an income stream. A friend of mine has a full time career in technology and has leveraged his knowledge to write a blog to share his knowledge with other coders or PC users. It is unlikely to ever replace the income from his regular job, but it can create enough income to help his family get through a period where he is unable or forced to not work.

Many couples diversify by being a two job family. Having both spouses work is a mechanism for managing cash flow all the time. It's an equally valuable method for reducing income risk. The loss of one spouse's job would hurt, but it would enable the couple to minimize withdrawals from an emergency fund if one job were lost.

Build a business with excess cash flow from your current job. A close friend of mine grew up with an electrician, farmer, rancher dad and a dog raising mom. They started out with an electrical business. When the electrical business had good years, they used their excess income to fund the beginning of their farm. Later they started raising beef cattle. Several years after starting their ranch the electrical business had a couple bad years while the agriculture business was doing well and carried them through what may have been a very difficult cash crunch without a diversified income stream.

Passive income streams are one of the best way to reduce risk. Passive income is derived from something that doesn't require you to work at it all the time. My friend's Dad slowly made his electrical business passive as he handed the day-to-day operations over to another family member. He still owned the business and managed it from a high level, but he didn't have to go to work there every day to keep the income. Another passive income alternative is owning rental properties.

How much do I need to diversify?

The more diverse you can be the higher chance you'll have of managing through an income crunch. Building several streams of income that don't depend on one another will help.

Spreading yourself too thin is as big of a risk as putting all of your eggs in one basket. By building five or six $10,000 income streams you'll have a great deal of flexibility. You might also struggle to turn any one of them into a $100,000 income stream.

Find the balance that works for you between having only one source to fund your life and protecting the income side of your cash flow.

What are some of the best ways you've found to generate extra or more diverse cash?

First Time Home Buyer Credit

Some friends of mine, Corey and Sally, are considering buying a home. They've been thinking about buying a home for a couple months. They're now thinking about rushing through the process in order to take advantage of the Federal First Time Home Buyer Credit, which gives a refundable tax credit up to $8,000.

Corey and Sally are feeling pressure to make a decision because the credit expires at the end of April. I talked with them about their house plans the other day then had a follow-up conversation with a mutual friend of ours, Garth.

They're looking to buy a home for around $140,000, so on the surface the $8,000 looks like a compelling reason to buy now. The $8,000 credit is significant for Corey and Sally, so guaranteeing themselves a 6-percent savings isn't a bad way to start off. There is no guarantee they could get the seller (this is a pre-approved short sale on a bank owned property) to come down another 6-percent.

Garth wanted to make sure they'd considered all of their options and knew what they wanted in a home.

I agree with Garth's assessment around knowing what you want and considering options. Buying a home is far more than a financial decision. The place you will raise your kids, spend 1/2 of your time, and build your life is one of the most impactful decisions a couple will ever make.

Garth recommended our friends build a spreadsheet with all of the features and requirements they have in a home. The sheet should include everything from budget impact and square footage to location and school information.

Building a detailed spreadsheet with all of the features and home requirements will take a while and might slow down Corey and Sally's ability to get the home buyer credit.

Should they rush their decision?

I ran a quick analysis to see how much they would really save by purchasing now versus taking their time. I considered purchase price, a 5-percent down payment, that they'd add the credit to their down payment if they got it, and a 30 year mortgage at their pre-approved rate.

By buying now and getting the credit they would save $16,127 over the life of a 30 year purchase, $538 per year, $45 per month, and $1.47 per day.

I don't think the savings are as much as my analysis shows. Some portion of the home buyer credit is currently built into starter home prices. By that I mean, once the credit expires home sellers are likely to lower their price (if not the advertised price, the contract price). The market as a whole has factored in the home buyer credit today and will have to factor it out after April 30. If the market shifts Corey and Sally will save less by getting the credit.

The Decision

As I mentioned, a home buying decision is far bigger than finances. Your home impacts your time, the quality of your kids' friends and education, and several hundred other things.

In most cases, I'll make an argument that small savings add up to significant amounts over a lifetime. When we're talking about cutting a coke a day to save an extra $25,000 over the next 30 years, I'll argue for cutting the coke.

In this case, I'm taking the opposite approach. I'm recommending cutting the coke each day for the next 30 years instead of taking the federal tax credit. Corey and Sally won't get $8,000 today, but in the long run they'll most likely be happier with a well planned and analyzed house buying decision that costs them an extra $16,000 over the next 30 years.

Personal Savings Epidemic

Malcom Gladwell’s book Tipping Point argues that a minor event can create a dramatic change. Gladwell tells of a child coming to school with the measles. Within a few days every other student has caught the virus and is sick. Within a week they are all better and will never have the virus again. One child with measles can possibly affect hundreds of lives.

One of the things we can do with Everyone Can Build Wealth is help create a savings epidemic. Hopefully, one that lasts generations.

Each generation of Americans has typically had more than the previous. Generation Y immediately wants everything our parents have after 30 years. We’ve spent the first decade of our adult life accumulating things at a pace never before seen in the United States.
For most of the last decade the personal savings rate in the United States bordered on zero. From 2004-2007 it was a rounding error away from zero. Most of us were putting money into our 401k or other savings vehicle. However, most of us were treating our homes like an ATM. We’d refinance and withdraw cash at a rate faster, or as fast, as we saved.

Beginning in 2007, Americans started saving again. We could no longer withdraw cash from our homes and started to understand the difference between needs and wants. We stopped shopping on Fifth Avenue and started shopping at WalMart. WalMart actually experienced revenue growth during the fourth quarter of 2008 and through 2009, while most retailers reported reduced sales and profit.

A return to big box retailers over the specialty stores is just one area we started saving. Here are some of my favorite savings examples from the last 18 months.

1. We’ve got several friends who have gone back to using their wood burning stoves for heat.
2. Game nights and potluck are replacing eating out with friends.
3. Cable TV is getting shut off or at least scaled back.
4. Gas guzzling SUVs are being replaced by minivans and other more economical vehicles.
5. Home phones are being turned off since we’ve all got cell phones. I haven’t won this debate with Kerri yet, but I’m working on it.
6. The library is replacing the book store.
7. Vacations are getting smaller and being paid for in cash.

Reduced consumer spending will keep the economy from quickly breaking out of the slump. Slow recovery is probably best for our long-term financial health. We have become extremely dependant on imports, debt, and consumption in the last 20 years. A slow recovery is far more likely to permanently change behavior toward saving and build a stronger economic engine. Even in 2009 we only saved about 5-percent, so we still have a long way to go to save like other countries. Chinese citizens save nearly 30-percent of their income.

The “Great Recession”, as many pundits have dubbed it, is hardly one of Gladwell’s minor events. In the grand scheme of things, it will be smaller than we see it today. This recession has caused a tipping point in American saving. The change toward saving in our society hasn’t reached epidemic proportions yet, but it can. Let’s spread the virus!

Investing or Gambling

Ten years ago this month, I learned the most painful personal finance lesson of my life. In November, 1999 I had $3,000 to invest in the stock market. Everyone told me it was a great time to be in the market. I bought shares in several tech companies. Everyone was building wealth in tech, right?

By February, 2000 I had day (or week) traded my little fund to $6,000. At the pace I was on, I'd retire by 30. I upgraded my stock account to allow for trading on margin. Trading on margin means I borrowed money from my broker to fund more stock. I paid 8-percent interest, but my stock trading was earning more than 700-percent.

The day I got my $6,000 loan a friend of mine told me to buy stock in his employer. He gave me some detail about the technology that sold me on it being a solid idea. Basically, they were a typical year 2000 dot-com company; fast SPENDING tech company with no revenue and a great idea. I bought $6,000 of his company with his great tip in mind. Two weeks later the market turned sour. Because I'd bought on margin, every dollar the stock dropped caused me to lose $2 of my account value. Buying on margin essentially doubles your growth or your loss.

I received my first margin call around March 15. A margin call is a broker demand to deposit enough to bring your account value to the minimum requirement. Basically, the stock in my account might not cover what I'd borrowed from the broker without a cash infusion. The first margin call was around $1,000. I sent the check and kept day trading. Three weeks later I got my next margin call for around $3,000. I drained our savings account and had to sell a certificate of deposit (CD) we had bought for our son. I sold all of the remaining stock and closed my account the same day.

I learned a lot of lessons through my day trading expedition. The five biggest all deserve a post of their own. Here are some of the big ones. They all probably deserve a post on their own. I'll tackle that in the future.

1. Trading on margin is NEVER a good idea.
2. Trading stock and investing in a business are dramatically different things.
3. A broad-market index fund is lower risk and more likely to help you achieve your goals than picking individual stocks.
4. Diversify, diversify, diversify is to investing as location, location, location is to real estate.
5. A "hot tip" from someone with no financial expertise is best ignored.

What was your first personal finance lesson? How did it change your strategy?

Cash Flow: Keeping Cable TV Optional

The other day a salesman knocked on our door. He was selling satellite systems. He talked about why his product was the best on the market for ten minutes. He showed me how the monthly costs were better than cable for the first 12 months. Finally, he told me they'd install the system for free. Everything pointed to this being a better deal than my current cable.


The biggest question in my mind was, will I have a contract? I can turn my current cable solution on or off whenever I want with no cost. The salesman bounced around on features and savings, but didn't answer my question. Finally, after I asked again, he told me I had to sign a 24 month contract and the early termination fee was $180 for the first 12 months then it went to $60.

I did some quick mental math and came up with the result below.


After 12 months the satellite bill would increase to about the same as my current cable TV. By then I would have saved enough to make an early termination fee a non-issue and my monthly cost would be a wash.

From a long-term financial standpoint, switching was probably the best solution. One of my rules for finance is avoid obligating myself to future payments when possible.

I asked myself the following questions:

1. Are we likely to have cable TV for the next 7.2 months? Most likely.
2. Could I get my cable company to match the satellite offer? Worth a shot.

I took the satellite guy's information and told him I'd call if I decided to switch. Then I called my cable company. Within 10 minutes they reduced my monthly cost by $20. My new breakeven was beyond around 24 months, so I stayed with cable. More importantly, I avoided adding a fixed expense in case I ever need to minimize my monthly cash outflow.

What examples do you have of keeping fixed costs variable and optional?

More Hangers isn't the Answer

The other day I was helping my son hang his shirts. He didn't have enough hangers in his closet, so we went through his sisters' closets. We ended up a few hangers short of enough for all of his shirts.

I mentioned this to Kerri and she said she'd get more hangers. I've been pondering our predicament for a few days. I've been asking myself, how many clothes are enough? How many pairs of shoes does one person really NEED? What ways does too much "stuff" impact our lives positively or negatively?

We use a lot of hand-me-downs in our family. We've got an older son and an older daughter who pass things to their younger siblings and Kerri has two generous sisters who pass things on to our kids. The result is our kids closets are full. The other day I counted the shoes in our daughter's closet. She had 10 pairs of shoes. Kerri showed me that we'd paid for four of those pairs. I'm still hung up on 10 pairs of shoes, a closet full of shirts, and the message to our kids about how much stuff they "need".

We haven't decided if we should do anything about this situation right now. We don't seem to be overspending on clothing for the kids. But, are we creating a false illusion about the amount of stuff they should have?

What are the areas of your life where you have too much stuff? How have you managed the stuff battle in the past?

How much do we really have?

Have you ever bought something on credit only to realize you owed more on it than it was worth the next day? The first car Kerri and I bought was like that. We borrowed nearly the entire purchase price and as cars do, it started depreciating faster than we paid for it.

Calculating net worth is the exercise of figuring out everything you own, everything you owe and subtracting your owes from your owns. Net worth is second behind cash flow in determining your ability to build wealth. It's actually your primary metric for whether you're building wealth.

What you own:
Figuring out what you own is usually pretty easy. Figuring out how much it's worth is a little harder. Start by making a list of all of your major assets.

The things I recommend including are savings accounts, retirement accounts, home, vehicles, and possibly some of your toys worth more than $1000 like ATVs or RVs. Some advisors would suggest you not count vehicles and toys. I prefer to count them because you can sell them. I suggest using a very conservative valuation for both.

The things I would not include are furniture, animals (they die), anything consumable, and toys worth less than $1000.

Assigning a value to all of your assets can be really difficult. We'll talk through each of them.

1. Savings or retirement accounts: These are easy. Just grab your latest statement.
2. Home: You can assign value of your home based on a variety of things. Before the real estate boom crashed, I used the purchase price of our home. Since then I have started using online tools like zillow.com. They keep track of sales in your area to determine rough values.
3. Vehicles: I use kbb.com or nada.com to value my vehicles then I use 80-percent of the worst value they list (usually trade-in). I use this conservative approach because I'm confident I could sell them for that low amount if I ever needed or wanted to.
4. Toys: I don't have a lot of experience with toys, but my approach has been to watch local sites (in Utah KSL.com is best) to see how much sellers are listing their toys for. KSL.com allows sellers to mark items sold, so you can see what a sold item was listed for. I suggest being extermely conservative with toys and valuing them at 60-percent of what you see them selling for.

Assigning value to what you owe is easy. Get all of your statements out and write down the amount owed.

When you are finished with the exercise, you should have a table that looks like the one below.

What if you have a negative net worth? A negative net worth occurs when what you own is worth less than what you owe. Regardless of whether you have a negative or positive net worth, the goal is usually the same. You want to improve it.

Net worth can be improved either through cash flow or asset appreciation. We've covered cash flow at length. Asset appreciation occurs when the value of an asset increases. One of the reasons to invest in a stock based mutual fund is long-term growth or appreciation.

Over the last couple weeks we've looked at setting goals, measuring cash flow, and calculating net worth. These three tools are a significant part of a personal finance foundation.

What are the other things you consider foundational finance principles? I'd enjoy learning and / or writing about them.

Everyone Can Build Wealth -- An Example

One of the things I plan to do is share examples of people who live within their means, save, and have built wealth the really old fashion way--$1 at a time. I hope having examples will inspire us all to save for the future.

Growing up in the depression surely had a dramatic affect on many people. Some it caused to have a deep desire to possess things. Others learned the value of saving, saving, and saving for a rainy day.

Grace Groner may or may not have understood time value of money, but she certainly understood saving and frugality were a road to security. The Chicago Tribune tells the story of a woman who never earned very much, bought 3 shares of Abbott Labs in 1935, lived in a small home her entire life, was extremely charitable, and never showed her wealth to anyone. Even the donation she made at her death was not known in size until after her passing. Those three shares of Abbott Labs, her added savings, and the discipline to reinvest all dividends for 70 years ended in nearly a $7 million nest egg.

I'm inspired by this woman's resolve, discipline and generosity. Her journey to wealth resembles that of many "Millionaires Next Door".

Enjoy the article.

Josh

The Real Cost of Hobbies: Total Cost of Ownership

I've been in China for the last five days and didn't realize my blog site would be blocked there. It works in Japan, so I'm back. Sorry for the brief hiatus so early on.

Have you ever bought something only to find the total cost of ownership (TCO) is much greater than you initially thought? Many times a purchaser underestimates the real cost of a purchase by only considering the initial price.

Total cost of ownership is the upfront price plus any ongoing maintenance or spending required. A car’s TCO includes purchase price, insurance, gasoline, and maintenance. A hobby’s TCO is, also, likely to have ongoing expenses. For example, golfing might require the purchase of clubs upfront and ongoing costs for green fees and replacing balls or tees.

My family’s primary hobby is riding horses. My Dad put me on a horse as soon as I could stand and I always wanted to provide that same opportunity for my kids. As my kids have gotten older, I have spent a lot of time thinking about whether horses should be one of our hobbies. Total cost of ownership is the primary reason I often reconsider our investment in horses.

The best way to determine the TCO of a particular hobby is to annualize the upfront costs then sum the annual ongoing costs. Here is my analysis for a horse hobby.

I haven’t included the cost of a vehicle to tow the trailer because we need a vehicle one way or the other. Even when we didn’t have horses (we took a break from horses for ten years) we had a vehicle with the ability to tow a trailer. If we only had our truck for horses, then I would include it in this analysis.

Not all upfront costs can be recouped if you choose to get out of a hobby. Some of these costs become sunk (spent and non-recoverable) as soon as you make the purchase. With horses, much of the upfront expense can be recouped. For example, I could get most of my investment in a horse back if I chose to sell him after a year. I may even be able to make a profit, but would never plan on that as part of a hobby analysis.

Seeing the bigger picture of a purchase, like a five year horse hobby, helps clarify and understand if it is right for you. Most other costs associated with horses are optional, so this gives us a good feel for what we are committing to over a longer period. An exercise like this sure raises big questions when you see five years of horses might pay for one or two years of college. Total cost of ownership analysis makes us far wiser consumers.

Knowing this information before we decided to start our horse hobby helped us decide if it was right for our family. We have three horses, so the annual cost is a big investment. I wouldn’t have wanted to be surprised by the maintenance costs. Our entire family enjoys horses and it brings us together. We could have gotten that from a lot of hobbies, but the ancillary benefits swayed us to having horses. Our oldest son wants to be a veterinarian and animal experience is one of the biggest factors in vet school acceptance. Also, our kids have learned to care for something other than themselves, work for something they enjoy, and have patience and love for an animal. Horses are a good choice for us right now, but the costs are certainly something that keep us asking whether we're getting enough from our investment.

Most of my life I only considered the upfront costs associated with a purchase. TCO analysis has helped us make more informed decisions. It can be used for nearly any purchase or investment including homes, cars, or hobbies. If you are choosing between multiple items you can do the TCO for each then compare the outcomes. Many people use TCO to decide between purchasing or renting a home.

What other tools have you used to decide if a purchase or hobby was right for you and your family?

Cash Flow Continued

The other day we talked about how to determine your cash flow. What happens if you get to the end of the exercise and your expenses are greater than your income? Or, maybe they're just closer than you need to achieve your goals.

As we discussed, some expenses are necessary or fixed while others are optional or variable.

Analyze your optional expenses first. The first time I did this exercise we were eating out a lot, had two car payments, and were paying for cable TV. We were really struggling to make ends meet at the time. Many months we'd end with $20 to $50 left in our checking account. Our savings account was minimal. I didn't realize how much optional spending we did.

We chose to focus on a couple areas of spending.

Kerri and I both worked at the time and were eating out every day for lunch. We immediately switched to eating out once per week each. We saw savings of nearly $200 just by making this one switch. (NOTE TO SELF: You've fallen off this bandwagon over the last few years and could cut spending and calories.)

Vehicles certainly weren't optional for us. We both commuted 10-25 miles to work. Our vehicles weren't fancy and were roughly in line with our needs. We still felt there was some element of optional in our vehicles. We considered several options.

1. Sell vehicles and buy something for cash or lower payments.
2. Use $200 saved from not eating out to accelerate payoff.
3. Use wind falls to accelerate payoff.
4. Continue with the same payment schedule.

We ultimately chose to go with a combination of 1-3. We sold our car and bought a slightly older car. As a way to reduce expense further we were able to get a lifetime warranty on parts because we bought it from a salvage yard that rebuilt cars. We greatly improved our cash flow and saved ourselves significantly in terms of vehicle depreciation. Finally, a small kicker to our cash flow was the "new" car had a lower insurance premium.

After we swapped the first vehicle we decided to keep our truck and accelerate payoff. We added the payment from the old car plus started applying any bonus or overtime income to pay it off. Two short years later we had improved our cash flow and were applying both payments to Kerri's student loans.

Cutting all optional expenses wasn't our preference and isn't what I'm advocating. We decided to keep cable, although we went to a cheaper package. We also could have saved money by selling the truck. Eventually, we got serious enough about getting out of debt to sell the truck in exchange for a very utilitarian truck.

Not everyone will have such obvious optional expenses. Some of you might even have necessary expenses that match or exceed your income. Here are some questions you could ask yourself to identify opportunities to reduce fixed expenses.

1. Am I spending money on something I could get for free? I have a penchant for buying books. The library has been a great replacement.
2. Are our necessary expenses really necessary? An example is your home. A home is necessary. A 3000 sq ft five bedroom house might not be.
3. Could we sell something to payoff a loan? eBay, Craig's list, and other local sites have made selling things much easier. Paying off a monthly loan to minimize future cash outflows is a great way to help in the long-term.

What are your big optional expenses? How far have you gone to reduce expenses? In the near future we'll talk about the other side of cash flow--income.

Have a great weekend.

Josh

Cash Flow

I've heard people wonder how a seemingly unsuccessful company survives while a highly successful company suddenly fails. Often, success or failure is caught up in cash flow. Whether you're a multi-billion dollar corporation or an 18-year old college student, cash flow is a cornerstone to financial success.

My first lesson in cash flow came early in college. My tuition was paid by a scholarship, but I had to buy books then get reimbursed. I was employed and had a system for managing cash flow. Each pay period I deposited my paycheck then spent until my next paycheck came.

I'd been doing fine with this approach until I went to buy books for Spring semester. I had a reimbursement coming that hadn't arrived. I thought my checking account had enough money to cover books. A swipe of my debit card revealed it didn't. I stood there with books on the counter and no way to pay. A quick phone call to Mom and I was back in business, but I'd burned myself. What could I do?

Cash flow is one of the easiest and hardest things to tackle. This is the first in a series of cash flow posts that'll take us from figuring out where our money goes to deciding where our money should be going. Today we'll tackle figuring out where money is going.

For the first five years on our own, Kerri and I had no idea where our money went. For the most part, it wasn't hard to figure out. We were poor college students, so there wasn't that much to spend. Even then, when we finally figured out where we spent money, we were keeping Taco Bell in business.

Figuring out where your money is going is easy with a little discipline. I like to use the following process.

1. Receipt Bucket: Put a jar or container of some sort on your kitchen counter and keep every receipt for 90 days. Every receipt includes your utility bills and your afternoon diet coke. If you buy something with cash and don't get a receipt, write it down on a slip of paper. The goal is to keep track of every expense regardless of amount.
2. Categorize Your Receipts: Categorize all of your receipts at the end of each month. Choose categories that make the most sense for you. Your categories will probably become clear as you start looking through receipts. Mine were something like household (utilities and rent), automobile (maintenance, car payment, gas), and Taco Bell. I like to use a tool for this part. A spreadsheet is as effective as any.
3. Categorize Categories: Once you know your categories, you can determine which of them are necessities versus optional. Eating is necessary, Taco Bell is optional.
4. Total Necessary and Optional
5. Compare Your Spending to Income: How does it look? It didn't look good for us. We earned more than we spent over the 90 days, but not every month and had several relatively large optional expenses.

Once you've gone through this exercise, you'll have an output for expenses that looks something like the following table.

If you've come this far, you're on your way. Tomorrow we'll talk about how to improve your cash flow by managing expenses.

Josh

Begin with the End in Mind

Personal finance is like nearly everything else in life; if we begin with a clear vision of where we're headed, we're far more likely to get there.

Think about an achievement of yours. How did you start on the path? One of my first achievements was winning second place in the school spelling bee. Of course, I didn't set out to win second place in the spelling bee. My goal was to be on ESPN. However, I was a 12 year old with limited athletic ability. I wasn't going to make it as an athlete. My best bet was the spelling bee. So I set a goal to be the district and state spelling bee winner.

As you now know, I landed a LONG way from the stars I shot for. Personal finance goals can sometimes feel a lot like my spelling bee experience. They're a long way off and require a great deal of planning and discipline. With the right tools we can make it.

Ten years ago I set my first financial goals. I started with these three.

1. Become a millionaire
2. Retire early
3. Save 15-percent of my income every year

I realized later these goals were a good start, but were mostly about money for the sake of money. I kept these goals for several years before I realized that they didn't inspire me to keep saving. I needed life goals to make my finance goals meaningful.

Over the last few years, Kerri and I have developed a clearer picture of what we really want. Some of our goals for the future are to help our kids earn at least a bachelor's degree (a big topic for the future), see a baseball game in 20 different major league stadiums, and for our kids to not worry about us needing financial assistance when we're retired. We've got a long list of goals now and most have matured to being about life instead of money.

Most of our goals are long-term, so we felt a tool for checking our progress along the way was going to be necessary. We eventually found a model that has worked pretty well for us. We use the SMaRT goal approach.

Specific: My "retire early" goal always drew the question, what does that mean? A specific goal includes knowing what, who, when, and how. For example, we (Who) want to help each of the kids earn a bachelor's degree (What) by paying X (How) toward their education when they go to school in 2015, 2020, 2022, and 2026 (When).

Measurable: How do you know if you're progressing toward your goals. Each goal needs to include concrete criteria to determine if you're on course or not. We know how much we need to be saving to make our goal and can measure our progress from year to year.

Realistic: To achieve a goal you have to believe it's possible. We started out thinking we'd pay for four complete bachelor's degrees. After learning the high cost, we scaled back to make it more achievable. The kids will have to pay for part of school, but we're far more likely to not run out of money before child #4 heads off to school.

Timely: Goals need to be measured within a set timeframe. We know our kids will be starting college in 2015, 2020, 2022, and 2026. We know we'll need to save specific amounts by 2010, 2015, etc.

What are your life goals and how have they helped you develop financial goals? Have you found other models that help you stay on track toward achieving them?

Welcome and Thanks

Welcome to Everyone Can Build Wealth. Years ago, I read a book that stuck with me and altered my financial future—The Millionaire Next Door by Thomas J. Stanley and William D. Danko. I was amazed the average millionaire didn’t earn a six figure income. I was also surprised by the author’s research showing how wealth is relative to your income and lifestyle. They found anyone can become wealthy; they just have to live below their means and learn happiness isn't relative to wealth.

Ever since reading the book, I've wanted to help others build wealth. Everyone Can Build Wealth is intended to help you and me build wealth.

One of the questions you may be asking is, "What makes Josh a financial expert?" I'm not. I've got a lot of interest in personal finance and my journey over the last 10 years has been one of studying personal finance and getting an education the old fashion way—making mistakes.

You've probably picked up pretty quickly that I'm not a professional writer. I enjoy writing and want to develop my writing skills. My mom always said, "practice makes perfect."

I hope through my blog I’ll be able to help you learn, avoid my mistakes, and ultimately inspire you to build wealth which I know everyone can. I'm sure I'll learn as much from your posts as I'll teach with mine.

Thanks for joining me at Everyone Can Build Wealth. I hope you enjoy the ride.

Josh