Year: 2011

The Whole Truth

Do you ever watch the TV program House? You know how he never believes anything a patient tells him?

“Everybody lies”, is House’s line. If people think they are telling the truth, is it really a lie?

In the world of personal finance, everyone is overly optimistic. If you ask almost anyone how much debt they have, unless they have none, chances are their estimate will be significantly lower than the actual number.

Awareness is the first step in initiating any change. Before we can solve a problem (if there is one) we must clearly define it.

Two numbers you should know, that is really know, not guess, are your Debt and your Net Worth.

To determine your net worth draw a line down the center of a piece of paper (or use excel). In the left hand column, we are going to list your assets in the right hand column your liabilities (debt).

Assets-What you own Liabilities-What you owe
Checking Credit Card #1
Savings Account Credit Card #2
401K Credit Card #3
Stocks Student Loan
Home Value (www.zillow.com) Mortgage
Car Value (Kbb.com) Car Loan
Other Owed to friends or Family
Total Total

Now the trick here is to really do it. We are looking for the real truth here, not some optimistic interpretation of the truth.

Look up your balances, estimate your car value using Kelly Blue Book. Don’t go crazy trying to determine your home value just pick either Zillow or use your tax appraiser’s estimate.

Go to Annualcreditreport.com to get a free credit report, did you miss any debts?

Net Worth = Assets – Liabilities

Is you number positive (good) or negative (not so good)?

Either way your number is not you, it’s just a number that’s going to allow us to track your progress towards financial fitness.

The sum of you debt (liabilities) is the other number you want to track every month. As you use your income to pay off debt, your liabilities number will go down and your net worth will go up.

Write down these two numbers: Net Worth and Total Debt, along with today’s date and post them somewhere you can see them. Set yourself a reminder to do this exercise again next month.

If you really did the exercise – “WOO HOO! YEA YOU! CONGRATULATIONS!”; you’ve taken the first step towards financial freedom.

Good Debt vs. Bad Debt

In the world I grew up in there were two kinds of debt, good and bad.

Good debt was debt used to buy things that are going up in value, real estate, home improvement or education.

Bad debt was debt for depreciating stuff like clothes, vacations, dinners out etc.

Cars, even though they depreciate like crazy, got a pass and were ruled ok debt.

This is no longer that world.

In today’s world there is Bad Debt and Worse Debt and Toxic Debt.

Bad Debt is a 15 year fixed rate mortgage on a home that the payments are no more than 25% of your take home pay. How can this possibly be bad? It is debt. It has risk. It costs you money in the form of interest. It is as close to being “good” as a debt can get but let’s call it bad to remind us we want out of it as soon as possible.

Worse Debt is secured debt on rapidly depreciating cars, boats and other toys. In the old world, advisors would say a car loan was fine if paying cash would wipe out your reserves; after all you need a car. Depending on where you live and what you do for a living you might convince me you need a car, but you will have a very hard time convincing me you need a car loan. Buy a car you can afford. Can’t pay cash for a new car? Guess you don’t get a new car. Can’t pay cash for a 5 year old car? Try an 8 year old car.  Maybe you really have to have a car loan but if so, it should be a very small loan on a used car and you need a plan to pay it off really fast.

Toxic Debt paying 12-25% interest on stuff that has virtually no resale value is financial suicide. You did not need the stuff in the first place. If you carry a balance on your credit card it proves you could not afford the stuff. Don’t buy stuff unless you can pay for it.

Another form of Toxic debt is the school loan. This is new world. The price of tuition has gotten so high and the lure of easy loans is so strong that many graduate with huge loans that are totally out of line with their probable earnings.

The Financial Aid Officer sitting across the desk from you is the devil incarnate. You are selling your future. Be very, very, very careful.

Wake up! If you have been living by the rules you were taught and you’re not winning, it’s because the world has changed.

There is no good debt and right now is a great time to assess how you can adapt and win.

Radical Changes

Yesterday, we looked at Dave Ramsey’s 7 baby steps; these are steps almost everyone can follow. If you have an income, a reasonable level of commitment and some patience, you can make some real progress at becoming financially secure.

So what if you really want to go crazy with this thing? If you have a very early retirement as your goal, you might want to read what Jacob Lund Fisker has to say. Mr. Fisker has a 21 day makeover plan to get you on the path to save 75% of your income and retire extremely early. This guy is really smart. His is also way out under the long tail of our graph.

If you are willing to start questioning why we live they way we do; try:

The forest versus the trees Early Retirement Extreme: — written by Jacob Lund Fisker

In this blog Fisker explains how the actions of his deliberate and planned frugality interact.

Dump Stuff is a suggestion that Fiske makes early in his 21 day plan. He contends that a too big, too expensive house or apartment is one thing holding people back from achieving their goals. People buy or rent too much home so they have a place to put their stuff.

Small & Close are the words to have in mind when looking for a place to live.

Save Time & Money – Live close to work, recreation and shopping. You will save time and money on your commute and may be able to get down to one, or no cars.

Be Happy & Healthy – Walk or bike that commute to decrease your stress and improve your health. Spend some of that saved commute time cooking healthy real food.

Each of these actions has a benefit by themselves, but done together a real money saving synergy is created.

If we look at the opposite of the life he describes, we have a huge house in the suburbs, where no one can walk to anything.

Both parents must work to pay the mortgage, insurance, taxes and upkeep of our big house.

Commute times and costs are so high that three nights a week dinner is from a drive through.

The kids spend more time in the car shuttling from school to activity than they do playing outside.

At night the family zones out in front of their 52 inch 212 channel TV. No one has time to nurture relationships and everyone’s health suffers from lack of exercise, stress and poor diet.

How about that, we started off trying to save your money and instead we might just save your life.

Who is this Dave Guy?

For those of you that do not know, Dave Ramsey is a New York Times bestselling author, a radio host and the guy behind my enthusiasm for this new debt free life.

You can download his radio show as a podcast at itunes. Give it a listen; this guy is a hoot.

I’ve read lots of financial management books, because I read a lot and because I’ve always been involved in small business and money. By far, Dave’s is the simplest most straightforward advice out there. He doesn’t just tell you the theory, he has a very definite step by step plan and he motivates his readers to actually follow the plan.

After I read his book, The Total Money Makeover, we attended the 13-week class, Financial Peace University that many churches host. Still not having enough of Dave, I attended his week long, very intense counselor training.

The average family, while going through Financial Peace University, pays off $5,300 in debt and increases their savings by $2,700!

The foundation of Dave’s plan are the seven baby steps:

STEP 1 – $1,000 to start an Emergency Fund

Making a commitment not to borrow money requires that you have some other method to pay for life’s little emergencies like the busted water heater or the bad alternator on your car.

STEP 2 – Pay off all debt using the Debt Snowball

List all your debts, except for the house mortgage, smallest to largest. Pay minimums on everything except the smallest and attack it with everything you’ve got. When the first debt is paid off, take what you were paying on it; add it to the minimum on the second and work like crazy to pay it off. Keep that snowball rolling until all of the debt is gone.

STEP 3 – Build an emergency fund of 3 to 6 months of expenses in savings

$1000 is not enough money to handle a real emergency. Loss of job, prolonged illness or a death in the family may require much more. Almost universally, money experts recommend 3-6 months of expenses.

STEP 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement

If you were in debt when you started the program, Dave recommends stopping all retirement, college and other saving temporarily until you reach this step. Now it’s time to re-start your retirement savings.

Step 5 – College funding for children

While maintaining your 15% retirement savings, start saving for the kids college.

STEP 6 – Pay off home early

Now put all you can into paying off the house.

STEP 7 – Build wealth and give!

You have no payments. No car payments, no credit card payments and no house payment. You can really afford to build wealth and give.

Golden-Crowned Flying Fox

Recently while doing some research, I read a parent’s statement about teens and student loans, “Very few if any teens have any conception of what it means to have a loan or repay one. It’s just magic right now, you sign your name and money appears.”

I totally agree but I think we can amend the statement to read “Very few if any teens people have any conception of what it means to have a loan or repay one. It’s just magic right now, you sign your name and money appears.”

Teens are not the only ones that make life-altering decisions armed with almost no knowledge of the subject. Adults do it all the time.

How do you know what you know?

If I asked a group of my friends what they know of the Giant Golden-Crowned Flying Fox, most would reply nothing but let me google that.

Ask that same group what they know of student loans or home mortgages or car leases and they would admit to some knowledge on the subject. After all, these are things they’ve done, their parents did, their friends and neighbors do.

When I amended the statement to read, “Very few if any teens people have any conception of what it means to have a loan or repay one.” I didn’t mean most people have never had loans. Most people have taken out loans and most people have paid off some debt. However, most people, maybe even you, have never sat down and studied what that debt costs them.

Being familiar with a subject is not the same as being knowledgeable.

If you’re thinking of leasing a car, have you actually done a cost comparison? Put real numbers on a spreadsheet – including risk.

If you think keeping your mortgage is smart because of the tax break, have you computed those savings?

Let’s assume you have a $200,000 balance on your mortgage at an interest rate of 5%, that’s $10,000 a year that you pay to the bank. If your income puts you into a 25% tax bracket, then not having a mortgage (or interest to go with it) means you pay $2,500 to the government on that extra $10,000 in the form of taxes. Do you really think it’s smart to pay the bank $10,000 so you don’t have to pay the government $2,500?

When it comes to your future security and freedom, you need to treat every decision like the subject of the Giant Golden-Crowned Flying Fox.  You don’t know enough. Get online, get out the calculator or the spreadsheet and prove to yourself what you think you know. Read differing opinions and make your decision based on real information.

Turning a Dream into a Nightmare

My kid rode home from the hospital in a car seat – an approved, properly anchored car seat. The electrical outlets in our home were carefully covered with plastic safety plugs. I read him books and checked his homework and made sure he held my hand when crossing a street. I tried to limit his soda and french-fries and I encouraged him to drink his milk and eat his vegetables.

I bet you did the same with your kids.

As parents, we do everything we can to ensure the safety, success and happiness of our children. We want to give them every possible advantage.

Yet most of us stand by and do nothing when the financial aid officer offers them a student loan. It’s not that the parents or the students are stupid, they are just sucked in. We’ve been taught that it is normal to go to college on a student loan.  If NYU is your child’s dream, it seems that at the time it’s worth anything to make that dream come true.

It is not. The four year dream can become the 10, 15 or 30 year nightmare.

Do you remember you first debt?

What if it was a student loan in the amount $97,000 for a degree in Religion and Women’s Studies?

Let’s think about this a minute. Cortney Munna, the Religion and Women’s Studies graduate, will be making payments of over $700 for 15 years. How many recent college graduates do you know that have $700 a month available in their budget?

She will have to make these payments no matter what. Unlike credit card debt, student loans normally are not discharged with bankruptcy. And unlike a car or a house there is no asset to repossess. It is nearly impossible to have a student loan forgiven. It does not matter if Cortney should face a spell of unemployment or if her spouse or child should become ill, the payments are due and if she doesn’t make them her loan will be in default. Defaulted loans continue to accrue interest and collection charges.

Defaulting on a student loan can have very serious consequences. Garnishment of wages is one probable result. Additionally, the government can intercept your tax refund and/or take a portion of your Social Security disability or retirement benefit.  Another crippling consequence of a defaulted federal loan may be the inability to renew a professional license. View the excellent graphic The  Student Loan Scheme.

Even if Cortney is never late on a payment, she has started her life as an adult in a huge hole with tremendous risk.

So how could this have turned out different?

We have to love our children enough to say NO. NO you cannot cross the street alone when your 5, NO you cannot drink and drive and NO you absolutely will not go $97,000 in debt for a degree in Religion and Women’s Studies.

Would she have listened? If it were life or death, you could make your adult child listen.

This is life or no life; find a way to get through. Get her to talk to 5 recent grads in her field; look up starting salaries; make a budget of what life will be like after graduation. Work together and explore ways of getting the same results without the debt.

The Two Yous

You suffer from a split personality.

There is the “Thinking You” that wants to lose weight, stop smoking, read books or save money.

Then there is the “Impulsive You” that eats cake, smokes- but only when drinking, watches hours of mind-numbing TV or can’t resist a $6 Starbucks on the way to work.

The “Thinking You” is always yelling at the “Impulsive You”:  “Have some self-control.”

“Smart You” may win for a while but when you’re tired, or hungry or lonely or sad, YOU are going to lose.

Keeping a grip all the time is exhausting. It’s no fun and it doesn’t work. It is true that once new habits are well established things get a lot easier, but in the beginning before your desired behavior is a habit, it can be a battle.

So, how do you win?  Easy, you cheat.

If you need $150 a paycheck to go into savings to cover those non-monthly expenses like insurance, taxes, vacation and Christmas you have two choices. You can cash your check and wrestle “Impulsive You” for the $150 or you can, either through direct deposit or automatic transfer, have the money put where it belongs before you ever see it.

If the morning Starbucks is not in your budget but you routinely find yourself there, try one of these solutions:

  • If you can budget one a week you may be able to pacify “Impulsive You” by saying we’ll stop on Friday.
  • If your to-go cup is full with really good home brewed coffee when you leave the house, there is less reason to stop.
  • Can you take another route? Maybe pick up a co-worker on the way and enjoy some conversation instead.

Nobody knows “Impulsive You” like “Thinking You”. Plan around your temptations. Self-control is not an endless resource. At any given moment you’ve only got about a cup of it, use it up and you are at “Impulsive You’s” mercy for the rest of the day. When you know a situation saps your self-control, avoid it. Automate important or difficult processes so you don’t need to re-make your decisions every month.

Remember the kids that stared at the marshmallow? They ate it. They used up all their self control and the marshmallow was still sitting there, so they gobbled it up. The successful kids distracted themselves by looking away or singing songs.

Take a lesson from the 4-year-olds and learn to distract the “Impulsive You”.

Need a ride?

This is a graph.

Let’s call it our “How People Get to Work Graph”.

Most people live under the big fat part of the graph. They are driving financed or leased cars to work. They are obligated and indebted. They are normal.

Normal Sucks. (Please remember this highly technical financial phrase; it can make you rich).

If we move just a little to the right, we find people driving their paid off cars to work. These people are not entirely normal, they are not indebted (at least not for their car) and they have given themselves a chance to win. Dave approves of these people’s transportation.

Out to the right a little further, we might find two or more people car-pooling, sharing their transportation expense. Most of you are still with me here, that’s a scenario that you can wrap your head around.

But let’s go way out under the long tail. Here we can find people who have sold their car. They don’t have a car. They don’t have car insurance or maintenance or parking or gas expenses. They don’t have finance costs or depreciation draining their net worth. They are car-free. These people are way Beyond Dave.

Could you do this? Before you answer please notice I have my fingers in my ears. Go ahead a rattle off your 52 rationalizations why this is crazy and the people who do it are nuts and why it would never work for you. Done?

The average American spends nearly 20% of the income on transportation. Twenty percent, how much is that for you?

Edmunds True Cost to Own can give you an idea what it really costs to own different models.

These people without cars plan to live without cars. They live relativity close to work. This means not only do the save on transportation costs, but they may also save on commute time as well.

What would more time at home mean to you?

Would it mean you could get a load of wash done in the morning so everyone is less rushed and stressed in the evening? Would it mean you could cook dinner more often instead of picking up unhealthy and expensive drive through food? Could you get an extra hour with the kids?

Add this value to your twenty percent.

So, how do you get to work if you don’t have a car?

Buses, trains, subways and car pools work in some places.

Electric Bikes, bikes and walking work in others.

A combination of any of the above works in even more places.

I commuted by bike 10 miles each way for a number of years. I usually rode at least 3 days a week. It was good for my health and good for the budget. It wasn’t as good as being car free but it was much better than normal.

How far can get you from normal?

I Stepped in Something

Phew! I can tell. Go clean it off and let’s keep walking.

Simple, right? You make a mistake, fix it. You make a mess, clean it up. Not later. Now. Set things right so we can keep going.

When it comes to money mistakes, many seem to be reluctant to clean up their messes. They stick their head in the sand and wait for the problem just to go away.

The stupid new car purchase is a decision that many make and refuse to correct. The ridiculously high payments strain their budget, their relationships and their lifestyle. Rather than taking the hit and getting out of the mess, some people continue doggedly watching the resale value drop. All the while, their ability to get some traction on their goal is lost.

Maybe you’ve made the “too much house” mistake. If your house or rent payment is much more than 25% of your take home pay, you may survive but you cannot prosper. If in the near term you cannot increase you income you’ve got too much house. The real question is what are you going to do about it?

The same question must be asked of credit card balances. You can rant about the increased interest rates, about the higher minimums and the unscrupulous companies but what are you doing to get out?

If you took out a student loan last semester and now are starting to  understand this may not be  smart, don’t automatically accept one this semester. Just because you started down the wrong path doesn’t mean you can’t turn around.

Mistakes happen. If a lapse in judgment allowed you to make a money mess, forgive yourself, clean it up and let’s move on.