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?