Think Your Way to Wealth

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A problem I think many people have, and I know I do, is determining what to do next to take care of or improve your personal finances. If you are trying to get out of debt, increase how much you are saving, and spend less, it can be overwhelming to think about all of the things you need to do to get your financial life in order, and sometimes it can be hard to remember and keep up with all of the things you want to do, as well as all of the things that have to be done. Just like in David Allen’s Getting Things Done, I like to make a list of my next actions w/ my personal finances. I either leave it on my desk at home, or write it in the notebook I carry around, or both.

Here is a typical list from several months ago:

1. Review 401k asset allocation
2. Automate 529 account-set up electronic withdrawals
3. Set up separate online savings account for irregular expenses
4. Cancel gym membership
5. Pay all bills as soon as they come in -(recurring)
6. Make weekly payments on credit card-(recurring)
7. Plan next week’s menu-(recurring)

I like to prioritize, and place recurring items on the list at the bottom, which I may forget or put off if I don’t put them on the list. I try to do all of my recurring items on Friday (for example to plan next week’s menu so I can do any shopping over the weekend) so I get everything done before the weekend. Automating your finances can also decrease the number of things you need to remember on a weekly or monthly basis as well.

Filed under: Debt Reduction, Saving Money, Spending Money by RC - No Comments →

Free From Broke recently posted about his personal finance “tipping points”, and is holding a contest and asking readers to describe their own personal finance “tipping point”. He describes two financial “tipping points”, the first when you admit the situation you are in and resolve to do something about your finances, and the second when everything finally comes together and you see the end of your debt in sight. Since I haven’t quite reached the second point yet, I will talk about the first.
For me, the “eureka” moment came right after the Christmas holidays this past year. We made it through all of the Christmas shopping and extra spending OK. After paying off bills and realizing, although we didn’t add to our debt, we had made little to no progress on improving our finances over the last year, I really started thinking about our financial past a well as our financial future. We had basically been in “see-saw” mode over the last few years. We would run up some credit card debt, pay it down, and run it up again. We would build up savings, only to spend it down on things we though we needed. Assessing where we were at the beginning of this year, I realized the following:

Basically,we were not making any progress!!

Why Not?

• Lack of goals.
• Lack of focus.
• Lack of communication between myself and my wife.
• Lack of commitment to change our situation.

Things had to change, and after finding and reading lots of information on debt reduction and personal finance, as well as discovering several great personal finance blogs, I really started to focus on the things we needed to do :

• Start an emergency fund
• Pay off credit card debt
• Pay off other debt
• Save for a house
• Increase retirement savings

Basically execute a plan to live the life we wanted to, starting right then.

We are now making progress towards are goals, and the feeling is 180 degrees different than the one you have when you are not making any progress towards ill-defined or non-existent goals regarding your finances. Until you make a conscious decision to improve things, chances are they will never improve much. Carrying credit card debt and making only the minimum payments can keep you in debt almost forever.

Image by tyger_lyllie

Filed under: Building Wealth, Debt Reduction by RC - 5 Comments →

The debt snowball, a term coined by personal finance guru Dave Ramsey, is a debt reduction strategy where you take all of your outstanding debts, order them from largest amount to smallest amount, irregardless of the interest rate, and make minimum payments on all of them but one, the smallest. For the smallest debt, you pay extra, as much as you can, until you have paid it off. You then take the payment on that smallest debt, including any extra, and add it to the minimum payment you were making on the next smallest debt, paying that one off as quickly as possible as well. As each subsequent debt is paid off, you “roll” all of the previous extra payments and payment amounts from the paid off debts into the next one, thereby increasing the size of your “snowball”. It is a powerful concept, and seems pretty straight-forward and simple, doesn’t it? Quite a few people disagree with the method, however, claiming Dave Ramsey is bad with math because the smart thing to do would be to pay off your highest interest rate debt first, and the next highest next, etc. Others argue the “psychology” factor of eliminating the number of outstanding debts outweighs the amount of money you may save by paying off the highest interest debt first. So which side is correct?

Neither. A strong argument can be made for either side. It is true, that you will save some money if you pay off the highest interest debt first. But it is not because Dave Ramsey is bad at math. If you are better at math than Dave Ramsey, why are you in debt at all? His method does work, and thousands have followed it to success. Building on small victories (eliminating a debt source) is what the debt snowball is all about. The psychological factor cannot be totally discounted.

The correct answer, is, whatever works best for you.

I have recently, after building up an emergency fund, begun to focus on eliminating my credit card debt. However, I paid off my wife’s student loan last month, because the balance was low and I wanted to eliminate another recurring expense. I am now going to focus on my highest interest rate credit card next. After that, I may go back to paying the smallest balances in order. Seems I am jumping all over the place, doesn’t it? But it really doesn’t matter how you approach your debt reduction or how you order your debt snowball, as long as you have a plan you are comfortable with and stick to it. Tweak it, change it, do it in whatever order you want, as long as it works for you.

Image by gluemoon

Filed under: Debt Reduction by RC - 5 Comments →

Did you get a large tax refund last year?

Did you like getting a tax refund if you did?

While it was probably nice to receive a “windfall”, if you are still in debt or not saving enough for retirement, wouldn’t you rather have next year’s money now, to pay off debt at a high interest rate or to save for retirement by opening a Roth IRA, or save it in a high interest savings account? More than two-thirds of tax filers get a refund every year, with an average refund of over $2000. That’s almost $200/month that could be in your pocket now, if your refund was about average. I got a tax refund this past year, and although it was nice, I am changing my tax withholding to minimize the size of the refund I get next year. Look at it this way: If you have credit card debt at 15%, not only are you paying the credit card interest rate on that money when you could be paying off the amount this year , but you are losing an additional few percent to inflation.

If you do owe credit card debt or don’t have the money to open a Roth IRA, or just want to be in control of your own money, you should really consider changing your tax withholding by increasing the number of exemptions on your W-4 . Estimate the number of exemptions you should have on your W-4 by using the IRS Withholding Calculator on the IRS website.
Tips For Using The Program

• Have your most recent pay stubs handy.
• Have your most recent income tax return handy.
• Fill in all information that applies to your situation.
• Estimate values if necessary, remembering that the results can only be as accurate as the input you provide.
• Consult the information links embedded in the program whenever you have a question.
• Print out the final screen that summarizes your input and the results, then use it to complete a new Form W-4 (if necessary), and keep it for your records.

While it’s easy to look at getting a substantial tax refund every year as forced savings, I am sure you can come up with better uses for that money now. If not, change your withholding anyway, set up a direct debit from an online savings account such as ingdirect, and force yourself to save.

Filed under: Debt Reduction, Taxes by RC - No Comments →

A key to getting out of debt and on the path to financial success is to avoid using credit cards as a crutch when you don’t have the money to pay off an unexpected expense.  Even if you have been working to pay off your credit card debt in a responsible manner, a sudden medical bill or costly automobile repair can run your credit card balance right back up again.  One of the best ways to stop this from happening is by setting up an emergency fund to pay for life’s little surprises when they appear.

What is it ?

An emergency fund is exactly what it sounds like. A separate pile of money (i.e., a fund) that you use in the event of an emergency, like an unplanned car or home repair, unexpected medical expenses, and other similar unplanned and frequently unpleasant expenditures. The definition of what an emergency is is up to the individual, but it is important to remember that most things that can be planned for do not constitute an emergency, like regular car maintenance, replacement of appliances that are getting old and functioning poorly that you know will need to be replaced soon, vacations, Christmas shopping, and other expenditures that don’t really constitute a true “emergency”.

Why do I need one?

The main reason you need an emergency fund is that without it, or substantial savings in reserve (which would in effect serve as an emergency fund) it can be very difficult to break the cycle of debt you may be in, especially if an unexpected expense rolls in.  If every time you car breaks down, you use a credit card to pay for it, and you don’t pay it off every month, your balances will go up, you start paying interest, and the next thing you know you may be struggling to make the minimum payments. By starting an emergency fund, you are planning ahead for the unexpected, knowing that one day it will happen (which it will).

How much do I need?

If you are deep in debt, you should start with a small amount, say $1000 or so, and then focus all of your extra money you can scrimp together to pay off your debts.  I have just passed this point, using $2000 (since I have a family) and now I can focus 100% on paying off the rest of my debt. After you have paid off your debt, most people recommend 3 to 6 months of living expenses as your emergency fund, to protect you from smaller emergencies as well as a job layoff, etc.

Where and how do I start?

If you already have a savings account, it is OK to start there, but many people like to set up a separate account that cannot be accessed quite as easily (like a savings account can be with an ATM card).  Online saving accounts such as ING Direct are a great place for this, because the money is not quite as accessible, although you can get it in a couple of days.  They also pay higher interest generally, currently around 3.0%. You should begin by putting a certain amount out of your paycheck every two weeks, as much as you can afford, and can set this up automatically as well.

Once you have a “cushion” provided by your emergency fund, you can focus on debt reduction without having to worry as much about the unexpected events of life getting you into as much financial trouble as they once may have.

Reminder-  When you take money from your emergency fund, be sure to start putting it back to replenish it right away!

Filed under: Building Wealth, Debt Reduction by RC - 5 Comments →

I recently was faced with a decision that I believe many people have faced while trying to get out of debt. In an effort to pay off debt as quickly as possible, one would obviously like to direct as much money as possible towards debt repayments. Cutting back on luxuries or items you consider frivolous are not necessarily that difficult a decision to make, but you have to be determined to cut back in those areas.  However, one category where the decision can be difficult and not really clear-cut is whether one should stop making contributions to your retirement plan, either a 401k, 403b, or or other retirement savings vehicle in order to free up more money for debt repayment. I think there are several factors which can come into play when deciding which option is right for you.

• Age- I am in my mid-thirties, and while I have a strong desire to become debt free as soon as possible, my retirement age is getting closer and closer.  By stopping my contributions, I am basically delaying my retirement.  On the other hand, the younger you are, the longer you can contribute to your retirement savings, so stopping for a short period of time to pay off high interest debt may not hurt you too bad.  
• Whether your employer offers matching contributions- If your employer offers matching contributions and you stop contributing to your 401k, you are leaving free money on the table. Many employers match the first few percent of your salary that you contribute, or match 50% of your contributions up to a certain percent, which is what mine does.
• How much debt you have and when you expect to pay it off-I looked at the time-line I have set up for paying off my debt, and I hope to have it paid off by the end of the year, even with contributing to my 401k.  However, I could shave several months off this time frame if I stopped my 401k contributions. If the time frame were longer, I might consider stopping my contributions to shorten that period of time.

For me, after I though about it for a while, I decided it did not make financial sense to stop my 401k contributions completely, nor would I feel very comfortable doing so. I would be missing out on my employer match, which is 50% for the first 5% I put in. None of my CC debt has a higher interest rate than 50% , so what I am doing now is to put in the amount up to my employer match. If my employer did not make matching contributions, I would have to think really hard about whether or not I would stop making contributions, and I have a feeling I might do so.  But the automatic 50% return is too good for me to pass up. 

One thing this dilemma has inspired me to do is to try to pay off my credit card debt as fast as possible, and focus on earning more and spending less in order to speed up the process.  What are your thoughts on this issue?

Filed under: Debt Reduction, Retirement by RC - 7 Comments →

One of the things that people struggling to get out of debt and start wealth building have problems with is the use of credit cards. Frequently, credit cards are the reason people start getting into debt problems, and they can certainly exacerbate the situation.

You hear the same story over and over, someone will either work to pay off credit card debt, or take out a home-equity or 401k loan, only to start charging things again and building the balances on their high-interest credit cards again. Certainly, one can take measures to prevent this, by cutting up your cards, freezing them in a block of ice, etc. Part of the reason a lot of people, and I include myself in the number, fall back into their bad habits with credit card usage is a lack of an honest assessment of their ability to manage credit card usage in a responsible manner.

To make matters worse, there are certain benefits to credit card usage that many people find enticing. Cash back rewards cards or zero balance transfers give us the promise of “free” or “fast” money, with little or no effort on the part of the consumer.  But they are not without risks, especially for people who have had credit card problems in the past.  Part of the reason I am now digging myself out of appx. $10k in credit card debt is because, I believe, that I am in a “high risk” category. I have always had a problem with running up credit card bills for what I considered important stuff or “emergencies”. I am sure you can probably guess, most of these things were neither really important or real emergencies.

 However, I have always paid my credit card bills on time, and eventually in full, only to run them back up again.  I think that because I always paid my bills I felt like I was managing my credit cards, when in reality they were managing me. It has only been the last 6 months or so, when I came to the realization that I would never build real wealth by continuing along the same path, that I realized I even had a problem.  For me, it will probably be a long time before I will use credit cards on a regular basis again or get back into the “rewards” game.  I do feel like I would be responsible now, as I am not 100% credit card free anyway, but I don’t really fully trust myself.  I do still use them on occasion, but mostly for online purchases where I do not want to use my debit card, or for gas. I try to pay these off even more frequently than monthly. But I also have now built up an emergency fund to take care of real emergencies and no longer will rely on a credit card to bail myself out.

When you realize that your lack of discipline with credit cards is what likely got you into financial trouble in the first place, and don’t blame it on circumstances or bad luck, you then need to make a decision on whether you should really be using them at all.  Certainly, by stopping credit card usage for a length of time, one can begin to make strides on the road to becoming “debt free”.

By examining and determining your credit card usage “risk” potential, you can probably determine if you really should be jumping back into the world of credit card usage, balance transfers, or cash back rewards. Certainly, while many people are more than capable of using a credit card wisely and within reason, and can make money off of them, for others, frequently, the “rewards” are not worth the risk.

Filed under: Debt Reduction, General by RC - 1 Comment →

What’s the value of a dollar these days? Less than it was a couple of years ago, I imagine.  But what I am talking about here is the value of a dollar not due to inflationary effects, but rather on where that dollar is being utilized– and how much it really costs you. 

Let’s first look at paying off debt. For example, say you have $1.00 in credit card debt at 20% interest.  In order to pay off that debt you have to earn money, pay taxes on your earnings, and then pay off the debt. For the sake of simplicity, let’s say you are taxed at a 20% rate. You will have to earn $1.25 to pay off that $1.00. ($1.25 x 0.8 =$1.00). So to pay off that one dollar now, you have to earn $1.25.  Now suppose you put off paying that $1.00 for one year.  At 20% interest you owe, one year later, $1.20.  But to pay off that $1.20, you will have to earn $1.50 ($1.50 x .8= $1.20) one year from now to pay it off.

Now let’s look at building wealth.  Suppose you put $1.00 into your 401k account.  Since you won’t pay taxes on your contribution, that $1.00 only costs you $0.83 ($0.83  x 1.2 =$1.00) from your take home pay. So if you are building wealth with pre-tax dollars instead of pay off debt with post-tax dollars,  it costs you 66% less to invest $1.00 than to pay $1.00 in debt ($0.83/$1.25 =66%). If you want $1.00 a year from now, it costs you even less, depending on what interest rate you receive over the course of the year. Let’s assume 7%. You only need to decrease your spending by $0.77 now to have $1.00 in one year ($0.77 x 1.2 x 1.07 = $1.00). So creating $1.00 one year in the future only costs you $0.77 now.  If you delay paying off debt in the above example one year, it will cost you $1.50, or almost double what it takes to create $1.00.  If you were to throw in an employer match to your 401k contribution, you are talking about an even larger difference. 

(Now, I know I have not considered taxes when the 401k money comes out sometime in the future, but this example is to illustrate the difference in the price of debt (high) vs. investing, particularly over time. Even if you were to invest in a Roth IRA , to get $1.00 in a year at 7% would cost you $0.93 now, and be tax free, vs. the $1.50 for the $1.00 in debt if you wait a year to pay it off.)

These numbers show how much more it costs you to carry high interest debt and how it can actually cost less (to your take home pay) to invest, and should motivate everyone to pay off debt as quickly as possible, particularly non-deductible, high-interest debt, and begin investing. A great place to start is with pre-tax savings, to minimize the effect on your take home pay, certainly up to the employer match in a 401k if your employer offers one.

Filed under: Debt Reduction, Frugality, Investing by RC - 2 Comments →

America Saves, a nationwide campaign to help Americans save, reduce debt, and build wealth, is celebrating “America Saves” Week from February 24th through March 2nd.  Sign up for their monthly newsletter, and browse around the site for tips.

The Website has resources and tips such as the following:

Save for Auto Purchases, Save for Emergencies, Savings and Investments, Save for a Home, and Get Out of Debt.

 Visit their Savings Tips section for a variety of money savings tips.

They also have specific campaigns, such as Military Saves, Youth Saves, Hispanic America Saves, and Black America Saves.

Campaigns by organizations like “America Saves” are great for introducing people who are lacking in personal finance awareness to understand the concepts invloved, especially teenagers and young adults, but they frequently contain information beneficial for everyone.  I would recommend that you check it out and send a link to the website to anyone you think might benefit.

Filed under: Debt Reduction, Saving Money by RC - No Comments →

Sometimes, on the road to becoming debt free, or increasing your wealth, you hit a “wall”. Maybe you work late a few nights in a row, so you get too tired to plan out your meals and cook and end up eating out. Or you forget to pay bills and incur late fees, or have an unexpected expense which wipes out most of your savings. Or maybe you don’t see the growth in your savings or investing that you would like to see. You lose faith and are soon getting back to your old ways and habits.

How do you get back on track?

One way which has been useful to me, is to do something extreme. You have to take “extreme measures” to give yourself a boost and stop yourself falling back into bad habits.

Burn Bridges:
Eliminate your escape routes. Do something that limits your options.
Pay all of your bills as soon as you receive them, and put the rest towards debt reduction.  For example, say you are 10 days from payday, you have $1000 in your checking account, and you estimate you will need $500 for bills and food for the next 10 days. Well, take $499 and put it towards your credit card debt now, so you have you are left with $501 with $500 in expenses over the next 10 days. You have no choice but to live within your means with only a $1.00 cushion.

Do Something Extreme:
Don’t just drop your cable subscription, or Netflix. That may not be extreme enough. Drop your cable subscription and sell your television! (Now obviously, if you are married and have children, etc., you need to make sure they are on board!) Now, the TV is just an example, it could be anything, but you get the idea.

Pull an All-Nighter:
If you are falling behind on your bills, stay up late one night and take care of them. Or write out a plan for your debt reduction, step by step.

Sell one of your “prized” possessions:
This could be a collection, an autographed football, your motorcycle you only ride on weekends, or maybe just “stuff” you have laying around the house. Sell them to generate additional cash to assist you getting back on track.

Challenge Yourself with Spending:
Set an extremely low amount (whatever that may be for you), say $30 if you are single (whatever is a low amount for you), take it to the grocery store, and buy all of your grocery items for every carefully planned meal for a week with that money.

Challenge yourself to earn additional income or generate additional cash, such as $500 over the next 30 days.

One good thing about this strategy is that it forces you to come to terms with how badly you want to reach your goal. If you are willing to take extreme measures to reach your goals as quickly as possible, then your goals are obtainable. If you decide the sacrifices are too great to reach, you may need to rethink your goals and how quickly you want to achieve them.

Filed under: Debt Reduction, Frugality by RC - 8 Comments →