Where to put $1000: Starting a Lifetime Habit of Saving with a Cool Grand

First let me say that I encourage commenting on my site. I often receive requests for topics via phone calls, emails, or today, Facebook chats. If you ever have a question related to investing, paying down debt, or planning for the future, I welcome anonymous comments and promise to respond promptly.

So you've got a thousand bucks. Where do you put it? Today's post will talk about what you can do with that money instead of spending it. I will give you options based on priority. The options begin with keeping the money close in a savings account, then paying off high-interest debt, saving for retirement, and then investing in the stock market.

Where you should put your thousand dollars depends on who you are:

If you're Bill Gates, you should give it to charity. If you're Joe the Plumber, you should save it to buy your boss' business. John McCain should spend it on campaign ads. Barack Obama should save it for a moving truck, because I've got the sense that he'll be moving to Washington before long. But I digress...you're the one with a thousand dollars.

First of all, let me congratulate you on making the commitment to start saving. Like commiting to lose weight, deciding to save money is a wise decision that will enhance your life, boost your conficdence, and never be regretted.

Where to put your first cool grand is going to start with your financial plan. The highest priority that I recommend in any financial plan is to have a reasonable cash balance before putting money anywhere else. Deposit the thousand dollars that you have in your pocket in a cash account that is easily accessible, like an interest-earning checking or savings account. No, you won't get rich quick, but you should still keep it as close as you can without putting it under the mattress. Here are two reasons why:

1) It is in your best interest to have more cash available than you need on a monthly basis. Some say that it's a good idea to have three, four, five, or even six months worth of expenses in cash. I don't necessarily agree with six, but I could be convinced that three is a good idea. Extra cash is important because annoying financial circumstances arise all the time, and without a buffer, those annoying circumstances are likely to put you into debt. Two weeks ago, my car needed an unexpected repair that cost me $420. If I hadn't had the cash to pay for it, I may have had to borrow the money from a friend or, even worse, a credit card company. Keeping extra cash in the bank is essential to prevent those annoying, yet inevitable, financial inconveniences from becoming financial disasters.

2) The other reason to save money in a cash account is purely psychological. Though you're not going to get rich earning 3% interest, you'll never lose anything, either. Over the past few months, my stock portfolio has decreased about 35% in value. If you put your first thousand dollars of savings into the stock market and end up losing a third of it, you may be discouraged from saving in the future. Before investing in stocks or mutual funds, build up a stable collection of cash that will grow slowly, but surely.

So my first piece of advice about your thousand dollars is pretty simple. Put it in a slow-growing savings or checking account (check out a Schwab or E*Trade checking account) so that the money is accessible if you need it. Once you've built a nice cash reserve, it's time to look at debt.

Notice how my first priority was to build up a small cash reserve before looking at credit card debt. If you've got some cash in the bank, before putting your $1,000 anyplace else, use it to pay down/eliminate any credit card debt that doesn't have a low promotional interest rate (0-4%). Credit card debt is a real leach when it comes to personal finance and it should be eliminated before investing your in-hand money anyplace else. Start with the card with the highest interest rate and then work your way down.

If you've got a thousand dollars to invest and already have a cash reserve that you're comfortable with and no credit card debt, then I'd look into putting it into a Roth IRA. Why a Roth IRA? Well, it's a tax-advantaged retirement account into which you deposit cash-in-hand. Your other retirement options, like a 401(k) and a traditional IRA deal with pre-tax money; if you have $1,000 in-hand, it's after-tax money and can only be deposited into the Roth IRA retirement account. E*Trade, Vanguard, Fidelity, and many more companies offer Roth IRA accounts. Check out the no-load, no fee mutual funds (preferably one that is tied to an index, like the S&P 500), as they have the lowest overhead costs and tend to perform just as well as more expensive managed funds (the ones that charge you fees to employ a manager that tries to beat the market, but rarely does). If you're under 50, you can deposit up to $5,000 per year into a Roth IRA. Those 50 and older may contribute $6,000 per year.

I could go on and on with additional investment advice related to stocks, CDs, money market accounts, or retirement. But we're talking $1,000 here. In summary, if you have an extra pile of cash sitting around, whether it's $100, $500, or $1,000, here's what you should do with it:

#1 - Make sure you've got extra cash in your checking/savings account that you can easily access.
#2 - Once you've got a little extra cash in the bank, use the money to pay down/off any credit card debt that you have, starting with the highest interest rate (not the smallest balance).
#3 - When you have no credit card debt, open a Roth IRA or contribute to one that you've already opened. Be sure to invest in no-load, no-fee funds, as they have very low costs and tend to perform just fine. Look for funds with a Net Expense Ratio under $.50.
#4 - Only after saving up some cash, after paying off high-interest debt, and after putting the maximum amount into a tax-advantaged account should you consider investing any serious amount of money in stocks. With a Roth IRA, your gains will never be taxed. With stocks, all of your gains will be taxed.

If you've made the commitment to start saving, pat yourself on the back. You won't regret the decision to live a financially healthy lifestyle.

What the 1% Fed Funds Rate Means to You, Your Neighbors, and Your Neighborhood Bank

First let me say that I've got good news for you: If you're reading this blog, you're probably not going to be as affected by the troubles of today's economy as someone not reading my blog. Many of my readers are young 20 or 30-somethings that navigated here from Facebook or Twitter (yes, I keep track of my demographics!). Unfortunately for me (and them), I don't have a lot of older, fixed-income Americans reading my site. And they're the ones that are going to suffer the most in our troubled financial environment.

Yesterday the Fed cut its Funds Rate to 1% -- the lowest it's been since 2003. And the last time it was at 1% prior to 2003 was in about 1960. One might say that, historically, it's an uncommonly low rate. But what does it mean? Why is it so low? Should you be concerned? And who should really be concerned?

What it means:
You may be under the impression that when you go to the bank and ask for a mortgage, the amount the bank can give you is limited to the amount of deposits that it has from your neighbors. If you want to borrow $100,000 for a house, your rich old fogey neighbors down the street need to have at least that much sitting in their CD or savings account if you want the money...right? ...right?!?

Wrong.

Actually, if you want to borrow $100k from the bank, your rich old fogey neighbors only need to have $10,000 in their account. That's because banking regulations say that banks are only required to have 10% of their outstanding loans in reserves, a.k.a. "cash in the bank."

The Fed is the nation's central bank, and has kind of a big brother/little brother relationship with smaller, commercial banks. Commercial banks, eager to make bank (forgive the expression), lend out as much money as they possibly can every day because lending money is how they make money. But at the end of the day, when the little brother sees that he's lent out$150,000 and only has $10,000 in cash reserves, he knows that he's broken the rules (he only has 6.6% reserves, not the required 10%)...and he had better have that 10% before close-of-business (a.k.a "when dad gets home"). So what does he do? He goes to his big brother (the Fed) and asks, "Hey bro, can you spot me five grand before dad gets home? I promise I'll pay you back tomorrow...and with interest!" Big brother lends him the five grand, and the next day, as promised, little brother pays him back with interest equal to the Fed Funds Rate.

Because commercial banks are in the interest of maximizing their profits, they lend out as much as they can every day. But they never really know for sure how much cash they'll have at the end of a given day, so there's no way to know for sure how much they can loan out on a given day. If they lend too much (more than nine times their deposits), they'll need to borrow money from the Fed. But if little brother knows that he can borrow money from his big brother overnight at a mere 1%, he won't be as afraid to lending out more than he's allowed.

Why it's so low:
Big brother knows that loans are important to his little brother and all of the people that he lends to. And big brother helps out wherever he can. Well, the big problem as of late is this: the little brother lent lots of money to subprime borrowers, many of whom never paid him back. So all of the sudden, the cash reserves of his little brother diminished. Now, instead of using his cash in the bank as a reserve for making more loans, he is using that cash to cover his costs associated with foreclosures. And because more and more people aren't making their mortgage payments, he has less and less money that he can use as reserves for new loans.

Think of it this way: if a foreclosure costs a lender $70,000 (which is realistic), it means that lender will have to decline $700,000 in new loans. That means that one foreclosure might prevent three or four qualified people from getting a mortgage.

Many of the little brother's customers -- even those with good credit -- can't get new loans. It isn't anything personal -- he just can't afford to lend to them! These customers are both businesses and individuals. And when businesses can't get the loans they need, it sometimes leads to layoffs, which in turn leads to more individuals defaulting on their loans.

With all of this chaos in the air, big brother stepped in. "Hey little brother -- I see you're having tough times. Go ahead and loan to those people with good credit. If you need to borrow some money, I'll lend it to you for next to nothing." By lowering the Federal Funds Rate again and again -- eventually to 1% -- the Fed is attempting to give banks the wiggle room they need to be able to start lending again.

Should YOU be concerned?
With the Fed lowering rates, it will effectively drive up inflation, which has both upsides and downsides. Lower rates cause inflation because banks can more easily get money. And when money becomes easier to get, that means that it's worth less. As money becomes worth less, more and more money is required to buy the same things.

At first, this sounds bad. But in reality it can help some people. Those with long-term fixed-rate loans, like student loans or a mortgages benefit greatly from inflation. Essentially, they're repaying a loan over a long time with money that's becoming worth less and less. On the flip side, inflation is the key driver for increasing home values. So those that own homes are seeing inflation drive up the value of their property. Because of the fixed-rate nature of mortgages (though some are variable) and the general increase in property values over time, owning property is, for the most part, a good investment. Without inflation, this theory might be different.

Additionally, most working professionals get a raise every year that resembles the rate of inflation. This raise is often referred to as a cost of living increase. It is meant to offset the burden of inflation so that it has less of an effect on our wallet. So if the cost of goods goes up 3% each year, you're going to be just fine if you get a parallel raise of 3%.

So why should you care about the 1% Fed Funds Rate? If you're a working professional that has a fixed-rate mortgage, owns a home in a stabalizing market, and get a cost of living increase each year, you're going to benefit from slightly higher inflation. Your mortgage will become easier to pay, your home will increase in value, and your annual raises will cover most if not all of your increased cost for everyday goods.

Who should really be concerned?
The elderly that are living on fixed incomes for the rest of their lives should be the ones to worry. They're the ones that aren't borrowing money and the ones that won't get a cost of living increase every year. If they're living in the last home that they'll ever own, it will become increasingly difficult for them to keep the home in their family; unless they sell it or get a reverse mortgage, they won't benefit from inflation driving up its value.

Also negatively affected by lower rates and increased inflation are companies and individuals working on a long-term fixed price contract. As money becomes less and less valuable, the benefit that they'll receive as time goes on will decrease until their contracts are renegotiated.

Keep in mind that banks are included in the list of companies that work on long-term contracts (in the form of fixed-rate mortgages). With the Fed lowering rates, though their immediate costs of getting money may go down, they know that inflation will make the money that they'll receive in future payments worth less. Anticipating the decreasing value of the dollar, they'll need to increase the rates at which people borrow from them. Last week 30-year fixed mortgages were at 5.92%. Today, they've shot up to 6.35%. On a $200,000 mortgage, that rate increase would increase your monthly payment by $55.64.

Because of this significant mortgage rate increase, you should be concerned if you have yet to buy a house. A decrease in the Fed Funds Rate will increase mortgage rates and may therefore decrease homeownership. In 1980, inflation was at an astounding 13.58%. Interest rates for mortgages often exceeded 11%. Therefore, in the early 80s, my parents lived in a trailer.

Summary:
- The rate at which the Fed lends to commercial banks was reduced to 1%
- This gives banks wiggle room and makes it easier for them to make new loans to businesses and individuals
- Those that will benefit from the rate cut are homeowners with fixed-rate mortgages and those with jobs that offer annual cost of living pay increases
- Those that will be hurt are those living on fixed incomes and those committed to long-term fixed-rate contracts
- Increased inflation caused by the decreased cost of money will increase mortgage rates and therefore make it more difficult for first-time homebuyers to afford a home.

In case you were wondering: Yes, I was conceived in a trailer.

Three Parts of a Practical, Effective Budget

Many times I've recommended creating a personal budget to help you meet your financial needs. It doesn't sound too difficult, does it? Believe it or not, the hardest part is finding the discipline to stick with it and give it the care and feeding it needs to be effective. It's easy to add up your income and divide it across all of your expenses/savings goals. But budgeting is more than that. In this post, I'll tell you the three important items that you'll need to have an effective budget: a Budget "Thermometer," Running Total Tracker, and Cash Planner.

1. Budget Thermometer








Here is a sample of my budget thermometer for September. It is simply a screenshot from my favorite free personal finance software, mint.com.

Coming up with categories and their monthly allowances is an important first step and the part of your budget that you will pay the most attention to on a daily basis. Mint.com not only allows you to create your budget, but it will show you a daily thermometer to display how well you're adhering to your plans. Because it's integrated with your bank and credit cards, each day it will classify your spending transactions and tell you whether or not you're on track to meet your monthly goals. If you spend half of your grocery budget by the 5th of the month, Mint will alert you so you can rein in on your shopping until you're back on track. As you spend money in a category, your little "thermometer" will fill in. Its color will change if you're on pace (green) , not on pace (yellow), or over your monthly budget.

I can't tell you how to split up your income each month, but here are some tips:

- Before creating your categories and their associated monthly allowances ($500 on groceries, $200 on restaurants, etc), take a look at where you currently spend your money and don't just pull the numbers out of thin air. If you're using personal finance tool like Mint, Quicken, or Money, you should be able to see a pie chart that shows you how you've spent your money in the past. But make sure your past transactions are classified correctly!

- Next, establish new goals for each of your categories. It's OK (and encouraged!) to spend less each month in certain categories than you have in the past. If you spent $400 last month at restaurants and want to bring that down, this is the perfect time to set those goals. Make sure you're using reasonable and achievable estimates for everything, but don't be afraid of a challenge.

- Don't forget about your savings goals! If you're saving up for something specific like a vacation or an engagement ring, start implementing those goals into your budget as categories after you've figured out what you'll have left over. Whether it's $10 per month or $500 per month, it's important to put money away for the things you'll need in the future.

- Don't budget down to your last penny. We're dealing with your personal finances; you're not an accountant. I like to leave out 2.5% of my monthly net income (after-tax pay) unaccounted for. There's no doubt that at least one of my expense categories will go over one month (as you can see above), so it's nice to have a little buffer for such an occasion without throwing off my other goals.

- If there are expenses that aren't incurred monthly, like car insurance or, in my case, my dog's annual vet visit, split them up in terms of months. Divide your six-month premium by six and use that as your monthly budget. This, of course, means that you'll be under budget some months, and over budget the months that the expense is paid. This point illustrates the need for the other two pieces of an effective budget: a Running Total Tracker and a Cash Planner.

2. Running Total Tracker
Unless you're an incredibly disciplined, you're not going to spend exactly the same amount of money each month on all of your categories. Certain things like your car payment, mortgage, etc are fixed, but other expenditures like groceries, clothing, and utilities will vary a bit. This is why it's important to track running totals.

Mint does not have running total tracking functionality, so I do it myself once a month in a spreadsheet. Two of my columns are identical to my categorical budget columns that are tracked by my personal finance software. One column has the identical category and the next has the monthly budget. Each month, I evaluate my monthly adherence to my budget and note the amount that I was over or under for each category in a new column; I have columns for each month that I have been using the spreadsheet. If my restaurant budget is $140 and I only spend $90 in September, my September column would have a green "$50" because I spent $50 less than budgeted. If I had spent $150, my September column would have a red "$10" because I spent $10 more than budgeted.

Next to the first two columns that display spending categories and their monthly allowances, I have a third column with a number that is either red or green. This number represents the sum of all of the monthly over/under amounts, which I call the "running total."


The running total is important for me to know how well I'm adhering to my budget over time. Also, it keeps track of the balances of certain non-monthly expenses and can help when you create next year's budget. If you see that you're constantly spending more than your budget on gas or groceries, you might need to rethink your amount.

Additionally, the running total column can indicate whether or not my wife or I can afford greater than normal spending in a certain category. Recently she said she wanted to go clothes shopping. We hadn't spent any money on clothes in a few months, so when I checked our running total for clothing, I saw that we were about $123 in the green. Because we hadn't spent our $50 clothing budget in a few months, she was able to go and spend more money on clothes this month. When I update my spreadsheet next month, the running total will be back to zero.

3. Cash Planner
Our incomes and expenses aren't always regular and incremental. There are times of the year when we receive bonuses or incur extra costs. The third piece of budgeting is important to help you determine how much cash you'll have after receiving irregular income (possibly after getting your tax refund) and after paying your abnormal expenses (like the January post-holiday credit card bill).

This budgeting tool is also something that I track manually in Excel. Across the top are columns indicating two periods per month -- one ending on the 15th and the other on last day of the month. It's up to you to determine how small your time increments will be. Depending on how often you're paid, you can have columns represent every Friday from this day forward, or simply the end of the month.

For each column, I have a series of rows for my expenses and incomes. My income is a row and my wife's is another. My expense rows resemble my budget categories, but unlike my running total spreadsheet, they don't follow them explicitly. This is because not all of my expenses are paid on the same day of the month. Many of them, like groceries and my XM bill, are put on my credit card. Since my credit card bill is due only once per month, I have a single row for "credit card" that includes many of my regular expenses. Other expense rows include one for my mortgage, my car loan, and my student loan payment.

Two other important rows include "Additional Income" and "Additional Expenses." These will be places where you can input anticipated fluctuations in your income or expenses. If you know you're planning on spending $350 next month on your quarterly student loan interest, you can plan for that. If you're getting a big tax refund in the spring, put that in your April column. Add as many columns as you're comfortable with. If you want to plan out six months ahead, you may. If you only want to plan two months ahead, that's fine, too.

Next, for each period column, I enter the expected amounts for each row (if any) that will be applied during the period. For example, my mortgage and car payment are paid on the 10th of each month. For the column labeled 10/15 (representing the period from October 1st - 15th), I will enter the amount of my monthly mortgage and car payments as well as any income I expect to receive. Since my credit card and student loan payments aren't due until later in the month, those expenses will show up in the second column for the month, 10/31. Similarly, because my wife is paid only at the end of each month, I'll enter her income only for the second period.

At the bottom of each column, I do a little math to estimate my cash balance. I take the cash balance from the bottom of the previous column, add the incomes from the current column, and then subtract the expenses from the current column. This will result in my new expected cash balance for the period. For example if I had $5,000 at the end of the last period, received $1,000 of total income, and incurred $800 of total expenses, my new cash balance would be $5,200.

While the Budget Thermometer and the Running Total tracker are useful for tactical budgeting, the Cash Planner is great for strategic cash management. If you're trying to develop an emergency fund of a few months' salary, the cash planner will give you a good idea of how long it will take to reach your goal.

As you can see, there's more to budgeting than just coming up with monthly allowances for spending categories. To budget effectively, you must have reasonable monthly goals (derived from your past spending), the ability to monitor your adherence to those goals, a willingness to log your monthly adherence (running totals), and a view into the future to know what your financial situation will be and how soon you can achieve your goals.

What are your own personal budgeting strategies?

What if You're Upside Down on Your Mortgage and Need to Move?

In my previous post about being upside down on a mortgage, I said that you're probably not going to be able to move anytime soon. Well, what happens if you're upside down and need to move? You have options, but none of them are magical or ideal. This post will describe a few of them: borrowing money to make up the difference, negotiating a short sale, and foreclosing.

Two big variables that will greatly affect your situation are 1) the amount you are upside-down and 2) the degree to which you can afford to keep paying your mortgage. If you are upside down $50,000 versus $5,000, you're in a much more difficult situation. Likewise, if you're able to keep making your mortgage payments until you figure out a long-term solution, you're in a much better position than someone who is unable to make his or her payments. If you can't make your payments now, consider renting out the home after you move or drastically changing your current budget to make ends meet. When you move, rent a small inexpensive place. If your kids are in college, consider asking them to take time off or to absorb some of the costs themselves. Major lifestyle changes are difficult, but the effects of a foreclosure or a short sale can be detrimental; all efforts should be exhausted to ensure that neither of those two occur.

If you are upside down on your mortgage and are put in a position where you need to move -- whether it's because of a job transfer or an unexpected layoff -- the most ideal option is to keep your home until you are no longer upside down. This can be achieved by saving money to match your negative equity or waiting for the market to pick up. Three alternatives are described below in order from best to worst as they relate to your overall financial (and emotional) wellbeing.

Option 1: Borrowing the money
This is an option as long as you're slightly upside down and not really upside down. If your negative equity is no more than $10,000, you're not in such a tough place. By borrowing money to get out of the pinch, you're protecting your credit score from getting hit by a train and ensuring that you'll be able to get another loan sometime in your lifetime.

The best place to get a loan for $10,000 or less would be from a friend or family member. But if you borrow money from someone, they'll need to charge you interest (at least 4.52%) in order for the IRS not to consider it a gift. A person is allowed give gifts to another up to $12,000 per year.

If you're fresh out of rich relatives, there are other places to look. If you, your child, or your spouse is enrolled in college, you may be eligible to take out an additional student loan. The federal government will allow students and parents to borrow money in excess of actual tuition and fees to cover living expenses. It would not be uncommon for students and parents to be able to borrow an extra $7,000 or $8,000 per semester which is available in cash. These loans have a relatively low interest rate (between 6% and 8%), are repayable over a long period of time, and their interest is generally tax deductible.

I hate to say it, but if you're unable to get a favorable loan from a family member or the government, you may have to resort to using a credit card convenience check or obtaining a high-interest personal loan. I'm not usually a proponent of putting things on your credit card that you can't pay off immediately. But in this case, when a foreclosure or a short sale are your only other options, the convenience check is the lesser of two evils. I'd rather see you incur five or ten thousand dollars of credit card debt if it means you'll avoid a foreclosure or a short sale.

Option 2: Negotiating a short sale
Short selling is when you negotiate with the mortgage lender to accept a fair market price for the home instead of the amount that you actually owe. This is more likely to be accepted when home values in a certain area have dropped significantly. Though mortgage lenders are not required to modify your agreement and accept less than you owe, they may be willing to because it may prevent a foreclosure, which is very expensive for a bank. Basically, they would rather forgive $10,000 on your loan than incur $70,000 in costs associated with a foreclosure.

Short selling is similar to foreclosing, but it will ultimately cost the bank less money and permit you to buy another home a bit sooner. It is preferable to a foreclosure, but is only offered by some lenders to some borrowers, depending on the circumstances. I had to do a bit of research to confirm this, but short-selling on your home will cause as much immediate detriment to your credit score as a foreclosure.

Expect your FICO score to drop 200 or 300 points. Your new score will most likely preclude you from qualifying for a rental lease without a cosigner. However, with two years of good credit history following a short sale, you will probably be able to obtain a mortgage through special government-sponsored programs. If you had foreclosed, you most likely would be unable to qualify for another mortgage for at least four years.

If you want to short sell your home, two things need to happen. 1) The mortgage lender has to be willing (it helps to have a lawyer assist with the negotiations) and 2) you need to prove your insolvency. Basically, you need to show that you have no money that can be freed up to pay for the difference between what you owe and what the house is worth. If you have equity in another property, a car that is paid off, or a student enrolled in college, the bank will see these things and ask why you're not dipping into your other equity, selling the car, or taking your kid out of college to pay what you has originally agreed. Essentially, before the bank concedes a short sale, they will need to be assured that foreclosure is the only other option because you have no other means to repay the loan.

Option 3: Foreclosure
This is clearly the worst thing for everyone. Your credit score will be destroyed and its affects will be long lasting. You will be unlikely to receive any other type of loan for a few years. The only good news is that no negative item - including a foreclosure - can stay on your credit report for more than seven years.

Being upside down on a house is a tricky situation -- especially for those that need to move. If you're upside on the mortgage for your current residence, save as much as you can so you can eventually bring get rid of the negative equity. If you need to move, do whatever you can to keep the home until house values go back up. If you cannot keep the home, try to borrow money from a friend or from the Department of Education. Remember that it's better to put an extra five or ten thousand dollars on a credit card than go through a short sale or foreclosure. If you're unable to obtain the cash to get out of the red, try to negotiate a short sale. It's effects on your credit are detrimental, but not as long-lasting as a foreclosure. If your lender is unwilling to engage in a short sale, then foreclosure may be your only option.

How to Spot Your Family and Friends' Financial Troubles

I'm proud of my audience. I really am. Since becoming a regular reader of my posts, I'm sure you've long-since retired and are enjoying the fruits of your pre-retirement frugality on a secluded beach in the Caribbean or on your 40-ft yacht (for which you paid cash, of course). I'm thrilled that you've achieved financial independence, so today I'm going to reward you with a day off and a break from lending advice on your finances.

Now don't get me wrong -- I'm not going to stop talking about finances. But today, instead of talking about yours, I am going to talk about those of your friends and family and how to spot a problem. I'm going to talk about clues: those that indicate current trouble and those that indicate a future fiasco. The way I see it, family and friends are supposed to help each other through hard times and support each other during painful periods. For many, personal finance is a private subject that offers very little transparency for outsiders. Many times you can't detect problems with your eyes, your ears, and your nose, as you can easily do when it comes to identifying substance abuse. Instead, you will rely on your gut -- playing detective and piecing together the clues to support your argument that a problem -- or even crisis -- really exists.

Before you consider whether or not a friend of yours is having financial problems, you'll need to have an original suspicion; we can't investigate and confront everyone (like the nosy neighbor Martha Huber on Desperate Housewives). Many reasonable suspicions will come from a passing statement about credit card debt, the infrequency of pay days, the inability to pay a bill, the inability to save, or something else. Let's look at a few potential flag statements:

• "I have no idea how much credit card debt we have."
  Your friend's lack of knowledge of the amount of his credit card debt indicates a detachment from his own finances. Though his personal finances are private and he is unlikely to share his net worth with others, his own accurate view into them is absolutely critical to his financial wellbeing.
  
  
• "I'm just paying the minimums."
  This statement indicates an inability to sacrifice when repaying debt and/or a fundamental misunderstanding of the nature of revolving debt. As I proved in a previous post (the Cost of Credit Card Debt), paying the minimum on a credit card is about the worst financial decision one can make, second only to taking out a payday loan or using cash as kindling. If your friends are paying only the minimums on their credit cards -- especially if they continue to eat out and spend on non-essentials -- it shows that they are in denial of their situation and are likely in need of a friendly nudge to get the ball of debt reduction rolling.
  
  
• "Thank god that my spouse and I are paid on alternating weeks."
  Living paycheck to paycheck is part of being young. When I first graduated from college, it was important for me to analyze my paydays and sync them with my bills' due dates. But as I got older and was able to save a little more, I eventually got to the point where I had an amount equal to one paycheck sitting in my checking account. Once I hit this milestone, life became easier because I didn't need to strategize the days on which I paid my bills. But when you see friends and family in their 40s or 50s worrying about which day of the month they're getting paid, it can indicate a paycheck-to-paycheck lifestyle and therefore, a lack of savings (or at least liquid savings). Assuming he has a moderate salary, that lack of savings might come from excessive minimum payments on loans and credit cards or from current overspending. Additionally, this indicates that your friend struggles with budgeting and planning for expenses that fall far away from payday.
  
  

If your family and friends are quiet and don't give these kinds of clues, you can infer financial troubles in different ways. If you're good at doing math in your head, you may be suspicious of their spending habits if they just don't seem to add up. If you know that your friend has a salary of $30,000 per year, yet you see him going out for lunch every day, driving a new car, living without roommates, wearing expensive clothes, and watching a high-def TV, you can assume that he is living outside of his means. It's not easy to look at someone's lavish lifestyle and automatically assume that they're spending more than they make. But it can certainly be grounds for suspicion and, combined with other clues (like some of the statements above) be a strong indicator of financial trouble. If a friend or family member tries to keep up with the Joneses without having the means of the Jonses, they're setting themselves up for trouble.

So why do people get into financial trouble? Clearly, some are presented with circumstances which are out of their control, like a sudden illness or a layoff in a poor economy. But some get into trouble for other reasons. Here's my theory:

Have you ever heard the principle that a liar will begin to believe his own lies if he tells them enough? Eventually, his lies can be spouted off without guilt or remorse. I think the same concept can be applied to those with preventable financial troubles. The snowball will start to roll when the person initially buys something which he cannot afford. He'll lie to himself about the item's affordability, being well aware that he should walk away and abandon the need for instant gratification. "Oh, it's just a lousy TV. I can afford it," knowing deep down that it's not a good idea. Later, when presented with another opportunity to spend unwisely, the same person will more easily convince himself of the affordability of said unwise purchase, despite contrasting evidence. Eventually, when it's told enough, the lie of affordability becomes second nature and is no longer is perceived as a lie; and that's when it becomes dangerous.

Do you remember the first cigarette you ever smoked and how horrifying that first puff was? It was awful and bitter and burning and easily sworn off. But the second one was a bit more tolerable. And the third became somewhat enjoyable. Over time, you developed a habit and never looked back at how terrible that first drag was. On day one, your body was trying to tell you something. You knew it was bad for your health, but you found a reason to do it anyway, probably related to high school popularity (keeping up with the Jonses) or the relief of stress (instant gratification). Whatever cookie-cutter excuse you came up with on that first day, you used it again and again until you didn't need to excuse yourself any longer. Non-smokers, please forgive this example, but I hope you get my point.

I certainly don't condone sniffing into the business of others. Personal finance is often a taboo subject among friends and family and a confrontation can affect a person's sense of independence and pride. However, depending on the situation, financial troubles on their part may result in a bailout on your part. Depending on the size and nature of the debt, what was once their problem may eventually become your problem. The way I see it, family money is family money. The benefits and the detriments to one member most certainly have the ability to benefit or detriment another. In other words, though it may not be your business today, it may become your business tomorrow.

I welcome anonymous comments about the financial stuggles of your friends and family.

Free Legitimate Websites That Actually Help Me Save Money

Here on tepom.com, I encourage you to spend less money and try to give advice on where to put what's left over. Today I'm going to share some free websites that actually/legitimately/genuinely help me and my family save money.

Upromise - If you're ever going to pay for someone's education, this is a must. It's a free service that rewards you with cash back for making purchases from its marketing partners. The only catch is that the money needs to be used to pay for college, which is enforced by placing your cash rewards into a 529 college savings account. Prices aren't marked up, you retain promotional discounts, and you can shop normally as you always would. There is a neat little toolbar that will detect when you're at a partner's website and will automatically give your reward. For example, ShoeBuy.com claims to have the lowest price on the internet for shoes and they also a partner with Upromise. Last week, I bought a pair of sneakers at an already low price, received ShoeBuy's 20% Columbus Day discount, and then another 10% cash back into my Upromise account. On average, Upromise deposits $270 per year into my college account, and I don't have to change my shopping habits one bit.

You also get credit for shopping at brick-and-mortar stores and restaurants by registering your credit and debit cards with Upromise and using them at the establishments. Additionally, by making travel reservations online, you will receive a percentage back after your stay is complete; I get 3% back on all hotel stays in addition to the other reward points offered by the hotel. And if I had used Upromise before I bought my house, I would have received about $700 for using a Century 21 agent.

Again, Upromise is completely free and easy to set up. You will earn between 1-10% cash back on your purchases and you can continue to shop like you always have for the best prices on goods, services, trips, and more. If you happen to land at a Upromise-sponsored business, you automatically receive your reward. If not, no big deal.

Mint.com - I've spoken of Mint several times on my site. It is a free personal finance website that provides software similar to Quicken, but with a much nicer and simpler user interface. Mint is incredibly easy to use and quite powerful, too.

If you have ever wanted to start a budget or to have a single view into all of your accounts -- be they retirement savings, college funds, checking and savings accounts, mortgage and auto loans, or credit cards -- this is the place to do it. By securely entering your username and password for each account, Mint will access the site and place your transactions into a single list. If you've got an issue with your spending discipline, Mint can keep it in check by showing you your up-to-date adherence to your monthly budget -- how much you've spent so far at restaurants, clothing stores, etc in a graphical, colorful "thermometer."

Also, be sure to check out their new Investments feature that will show how well your individual investments are doing compared to the rest of the market. And if you're interested in comparisons, you can easily see how much you spend at Starbucks or Walmart compared to other people in your city or state.

Craigslist - I hate to sound like a dirty college student, but you'd be amazed at the great deals you can find on Craigslist on all sorts of things. It's local, the stuff is inexpensive, it's super-duper easy and completely free to use for both buyers and sellers.

I don't use it as religiously as some, but before I make any major purchase, I'll look there. When I almost purchased an electric lawn edger at Lowes for $90, I bought the same one on craigslist for $25. When I almost bought the $500 bunkbed set for my guest room, I found the exact same one on Craigslist for $80. When I was inches away from buying a $2,000 digital piano in a music store, I found a comparable one on Craigslist for $400.

And Craigslist is a good way for you to get rid of your old stuff and make money. One Saturday when we cleaned out the garage, I made a Craigslist pile and then turned it into few hundred dollars cash within a week. It was nice to be rid of my old vacuum cleaner, a printer, and an extra coffee table, and I was happy to help some neighbors get their own good deals.

Please leave a comment with your own online all-stars that are legitimate, free, and will put cash in your pocket.

How Young Americans Can Profit From Today's Economy

Economy got you down? Well then chin up, young folks! You haven't got as much of a reason to worry as your older neighbors do. In fact, today's down market could have an incredible positive impact on your retirement if you play your cards right! I'm going to show you why you shouldn't beat yourself up about the nightmarish economy, but rather why (and how) you should invest. But be careful -- this is by no means a free pass to completely overhaul your personal financial plan (if you have one). My core values still stand: get out of debt, don't spend too much, and save your money. Let's get started.

Random optional side-notes:
First let me say that conspiracy theorists and skeptics and hard-core political enthusiasts are welcome to give me their comments about how the bailout and/or the election of a Republican/Democrat will doom us all. They may think that capitalism as we know it is over and before we know it, the government's interest in our financial institutions will create a socialist (or even communist) state and my words will be rendered irrelevant. Well, I hope that doesn't happen. But if it does, it's completely out of our control. The purpose of this post is to help average young Americans take advantage of this economy so they will benefit later in life. Future relevancy aside, this post assumes that the economy and government will function in the future as it has in the past.

On another side note, if everyone followed my advice and became completely debt free, the nation's economy would actually crumble. But don't worry -- it's impossible for an entire nation to become debt free. There is literally less money out there than there is debt. Sounds crazy, but it's true. :-)

Today's economy could actually help today's youth, and this theory is partially proven with the principle of dollar cost averaging. Essentially, the principle states that an investor's exposure to risk (risk of losing your money, that is) is reduced by buying investments incrementally instead of in one big lump sum. This works because in the short term, the stock market fluctuates frequently and unpredictably. So by buying stocks incrementally, you spread out your investment, buying in small batches for varying prices. On the other hand, the long term market is very predictable and its fluctuations are uncommon, minimal, and easily spotted. As you know, the idea of investing in stocks is to "buy low and sell high." In the short term, because it is difficult to know when you're at a peak and when you're in a valley, it's better to just keep buying a little bit at a time; sometimes you buy at the short term peaks and sometimes you buy at the short term valleys. In the end, you end up buying stocks for a dollar cost that is an average of its short term peaks and valleys.

Let's look at an example of short term fluctuation. You have $1,200 sitting around that you can invest in the stock market. Sure, you can take it all and invest it immediately, but it would be better for you to invest $100 it each month for the next year. Or even better, $50 every two weeks.

If you had invested that $1,200 in a mutual fund last October in one fell swoop, you probably would have lost quite a bit of your money (the Dow was at 14,000 last October and is at about 9,000 today). Let's say you bought the stock at 10 dollars per share -- 120 shares total. Let's also assume that because of the poor economy, the market has gone down 3% each month for a year (a realistic estimate given our recent history). So at the end of a year, your 120 shares would be worth about $912 -- about $7.60 apiece .

Now let's see what would have happened if you had invested $100 per month instead of putting it all in at once. In the first month, you would have bought 10 shares ($100 investment/$10 share price). But in month two, you would have been able to buy more shares with that money. Because the market had gone down, that stock was selling for $9.70. The next month, it would be selling for $9.41, and so on. By investing $100 per month for the full year, because of the discounted price, you would end up with 143 shares instead of 120 -- 19% more.

By investing incrementally, sure, you still lost money, but you also bought 90% of your stock for less than you paid for it when the Dow was at its peak a year ago. Because the market has gone down in the short term, the average price that you paid for that stock has also gone down. But because the market always goes up in the long term, you'll be better off when you eventually sell your stock because you will have a lower average cost per share and therefore, more shares. And the more shares, the better. When the stock eventually goes back up, you'll have 19% more money. When the stock pays a dividend, you'll get dividends for 19% more shares. More shares equals more money.

Of course, this theory goes both ways. Dollar cost averaging minimizes your short term gains as well. But if you want to guarantee your success in the stock market while maintaining your sanity, you need to give up on the notion of becoming a millionaire overnight or being the next Jim Cramer. Yes, dollar cost averaging will minimize both short term losses and gains, but it also ensures that your long term benefits aren't spoiled by the unpredictable daily/weekly/monthly peaks and valleys of the stock market.

Short term fluctuations are impossible to predict unless you've got the research budget of an investment bank. But in the long term, it's much easier to spot your "elevation" and buy when you're in a valley. Since 1978, there are only a few very obvious valleys. There was one in the late 80s, one in the late 90s, one just after September 11th, one in 2003, and one today. Today, stocks are cheap. This stinks for retirees that need to cash out to pay their mortgage, but it's wonderful for younger Americans that are just starting to save.

Just as it's true that short term ups and downs are unpredictable and should be handled with caution, it's also true that long term growth is quite predictable and its ups and downs can be more easily exploited. In the long term, when the market is growing quickly, it becomes proportionately more difficult to make a buck. But in days like these, when the market is down, it's the perfect storm for young folks to buy low and eventually sell high.

Those that understand the principle of dollar cost averaging and incrementally invest will minimize their short term losses (and unfortunately, short term gains, too). And those who, in the long run, slow their investing when the market is up and hasten their investing when the market is down (like today) will retire younger and more quickly enjoy a financially independent lifestyle than their get-rich-quick peers.

What To Do About Student Loan Interest Capitalization

If you're currently in college and have student loans, you may have recently received one or more quarterly interest statements from Direct Loans. Current students are given the option to delay their monthly payments until they're finished with school, though interest may have already began to accrue. This accrued and unpaid interest is what this form details.

Statements will show a current balance along with a figure for Total Unpaid Interest. Though this is not an actual bill, it looks a lot like one because of the clear bold figure indicating how much you might want to pay and the inclusion of a pre-addressed envelope and remittance form. So should you pay it?

The short answer: Yes, you should probably pay it.

Unless you absolutely cannot afford it or if you have debt with a considerably higher interest rate than the student loan, I'd like to see you pay all of the Unpaid Interest. Basically, unless you're dead broke, have high-interest credit card balances, or if you've got a loan shark chasing after you, grab your purse and start writing a check to the U.S. Department of Education.

Here's why: If you make a payment toward this loan -- especially if it's only for the listed amount on the form -- you're going to decrease your tax liability for the current year. If you're in the 25% tax bracket and you have $100 in unpaid interest, a payment of $100 will increase the size of your refund by $25 even if you're using the standard deduction. This $25 far outweighs how much you would save in interest by sending that same $100 to a loan with a slightly higher interest rate that is not tax deductible.

My wife just received a quarterly interest statement for her student loans. Because she's enrolled in grad school, no payment is due at this time. Currently, the interest rate on her student loans is about 1% less than the rate on our auto loan. So I considered letting it ride on the student loan interest and making a larger payment this month on our auto loan. But because the interest on an auto loan is not tax deductible, even with its higher rate it makes sense to pay the Total Unpaid Interest on the tax-deductible student loan.

But keep this in mind: If you have debt with a higher interest rate than your student loans -- like an auto loan -- only pay the Total Unpaid Interest on your student loan, and never more. Payments toward principal-only should always be made to loans with the highest interest rate.

If you don't have an auto loan or credit card balances, consider paying the Unpaid Interest plus whatever extra principal you can afford on your student loan. But if you have more than one federal student loan and receive multiple corresponding quarterly interest statements, don't pay extra principal on a loan until you have paid the unpaid interest on all of your student loans, regardless of their interest rates. Any payment amounts that exceed the Total Unpaid Interest will go toward the principal balance, which is not considered tax deductible. If you can afford to pay more than the Total Unpaid Interest on all of your loans, first, write a separate check for each account's Total Unpaid Interest, and then write an additional check for the account with the highest interest rate (probably a PLUS loan) in the amount of your extra principal payment.

If you're a student and you don't have any credit card debt or a high-interest auto loan, pat yourself on the back!

Is Prosper.com dead? And what is a secondary market?

Anyone who borrows, lends, or regularly browses Prosper.com received an email from the site's management team about suspending lending activity for a while while they develop a secondary market. So what does that mean? Will we ever be able to lend or borrow again? And what on earth is a secondary market?

First of all, don't worry. Prosper.com is not dead nor will it be dead anytime soon. They're simply listening to users that write about the pros and cons of peer-to-peer lending (like me). Until recently, Prosper.com has been a very small fish in the big pond of lending. Now, they're growing to a slightly larger, more mature fish; they just need to pull the curtain for a few months while they renovate.

If you read any post on just about and blog that writes about Prosper, you'll notice that one downside for lenders is that any money that they invest is money with which they part until the loan is repaid. For example, if you lend $100 at 25% to someone, you will get approximately four dollars per month for 36 months. And if you all of the sudden you need emergency orthodontic surgery and absolutely had to have back that $100 that you lent, there would be no way for you to get it faster than waiting for the $4 monthly payments to add up.

But let's say you had a really good friend named Steve that noticed you were in a pinch. Steve sees that you lent out this money a few months ago but need it back today. Seeing that the lender still owes you about $120 over the next two and a half years, he offers to give you $100 today if you agree to give him the remainder of your $4 monthly deposits. You benefit by cashing out when you needed to and Steve benefits by taking control over a reasonably profitable investment ($20 in this case) .

But let's say that my other friend, Dave, also sees my predicament. He wants in on the investment, so he says that he'll give me $105 for the remainder of my payments. Sure, he'll make a little less profit than Steve, but he likes the idea of making $15 profit on his $105 investment. Steve isn't willing to pay more than that, so Dave ends up "winning" your loan.

Essentially, the offers of Steve and Dave to purchase of your stake in the loan represent a secondary market. A secondary market is a place where investors can bid on securities -- including bonds, stocks, and in this case, loans -- after initial public offerings have already been made. In the case of Prosper.com, the initial public offering was the original loan listing.

After you bid on a loan and give some money to another person as an investment, a number of things can affect the value of that investment. Let's say that statistics show that borrowers that make their first 10 payments on time are 50% less likely to default than people who have only made their first five payment on time. Therefore, anyone holding a loan to a borrower that has made 10 payments on-time could sell those loans for a higher premium on the secondary market. Or if you're an secondary market investor, you could buy up a bunch of loans that are currently late for pennies on the dollar. The original lenders are happy because they're able to get some money back, but you'll clean up if you can convince the delinquent borrowers to pay up.

The secondary market is a key part of our economy. Without it, stockbrokers on Wall Street would have pretty boring jobs. Without a secondary market, our investments in stocks and bonds would have very little liquidity. If we invested in stocks, we would only be able to cash out when the company agreed to buy that stock back from us. Or if we wanted to get our money out of a 30-year bond, we would have to wait the full 30 years.

Prosper.com wants to create a regulated, large-scale secondary market for their loans. To do this legally, they need to file with the Securities Exchange Commission, which takes time. But after the filing is complete, more people will be encouraged to lend because they won't have as much of a risk of having little liquidity. Basically, current lenders who run into financial troubles of their own will no longer risk not being able to get at least some of their money back. The secondary market will positively affect borrowers, too, who can expect to get lower rates on loans, as the risk to original lenders losing all their money is reduced; lenders whose borrowers are late will be able to sell the loans. And because their liquidity is increased, lenders will more likely invest more money.

Let's just hope that Freddie Mac doesn't start buying up loans made to High Risk borrowers, packaging them together, and selling stock in their "High Risk" fund. As our recent economic troubles showed us, that's just asking for trouble.

Will Prosper.com's development of a secondary market encourage you to start lending?

When Do We Eat? The Value of Financial Individuality

Do you remember when you were growing up and your mother told you that you were special? Or maybe it was a teacher or your grandmother or a family friend. Chances are, a caring adult in your life encouraged your individuality and, more importantly, your independence. The lesson may have been taught in different ways, but was nonetheless important. Maybe you were encouraged to think twice before jumping off a bridge if all of your friends decided to do it. Maybe you were taught to "just say no" when presented with an opportunity to engage in an activity that threatened your moral fiber. However it was taught to you, I'd like to discuss the lesson's importance and relevance to your financial wellbeing.

Individuality and independence are important traits for people to possess in many respects. The right kind of individuality will set you apart from other candidates when applying for a job or admission into college. The wrong kind of individuality might earn you inquisitive glances from strangers and fearful looks from small children clutching their mothers' legs.

The ability to think critically and independently will also fuel your ability to responsibly manage money and increase your wealth. Lots of Americans have been frightened of the downward trending stock market and have been selling their stocks like nobody's business. The band wagon is speeding away from Wall Street just as fast as its little wheels can carry it, and the value of our investments are falling as a result. But just because so many people are jumping on, should you do it as well?

I guess it depends.

When I was in college, the most popular dining hall was called West End Market. It had a fun atmosphere and the food was diverse and delicious. But in my opinion, it was an absolutely miserable place to be at 6pm. Every evening, West End looked like Times Square on New Years Eve. Hokies arriving at dinnertime lined up like motorists at the DMV, often waiting more than 30 minutes for a sandwich or a plate of the ever-famous Chop House london broil.

I like eating at a normal time like everyone else, but being the impatient person that I am, one experience at West End during dinnertime was enough for me. I avoided it altogether for months, eating at the non-award-winning dining halls, until one day when I decided to pop in an hour early. You'd be amazed at the difference that hour made. At five, though I had worked up less of an appetite, I could hear crickets chirp as I leisurely approached every food station that I desired. Free tables were bountiful and I was able to feast in peace like Kevin McCallister on Christmas Eve. At six o'clock, patrons would be reminded of an overcrowded high school cafeteria on a day where all but one of the lunch ladies called in sick. Sure, it was easy to socialize, but those that came with the crowd wished they had brought a snack for the line.

So what does a dining hall have to do with investing? Well, when everyone is selling -- to the point the Dow falls to its lowest value in five years -- you have to ask yourself what your strategy is. You might not be starving until six, but at six, everyone will be starving. So chances are, you might not eat until seven. So you have to ask yourself, are you a six o'clock person? Or are you a five o'clock person?

The six o'clock person will sell, sell, sell and wait until the market is trending upward before they buy again -- just like everyone else. The five o'clock person will start buying when no one else is. He will understand that stocks are on sale and remind himself of the history of the market, which has always stood the test of time, despite its sometimes significant peaks and valleys. He's not famished yet, but he knows that hunger will come soon and he had better get in line before everyone else does.

Warren Buffet once said "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well."

Of course, investing in the stock market during a troublesome time is much more complicated than determining what time to go to dinner. But at a high level you have to ask yourself why you're there. Are you there to socialize? Or are you there to eat?

Guidelines for accelerated loan payoffs

If you've been frustrated with the faltering markets lately, as have most Americans, you've probably been discouraged from investing your disposable income into the stock market. That could very well be the correct choice for you and your family, depending on your financial plans and tolerance for risk. But if you're not investing in the stock market, what are you doing with all that money? Are you putting it in a savings account? Or a CD? Or are you paying down debt?

My personal financial plan calls on paying down my debt during the economic downturn. The markets have been unpredictable (and by unpredictable, I mean they're going straight down) and the amount of debt that my wife and I have will take a relatively short amount of time to pay off. We're hoping that when we're out of debt in a couple of years (excepting our mortgage), the market will be trending upward and we'll have a larger portion of our income to regularly invest, given the fact that we'll have no regular payments for our auto or student loans.

If you're going to start paying down debt in lieu of investing, consider the following three guidelines to help you prioritize where your money is being sent:

1. Pay off the loans with the highest interest rate first (as long as they're not tax advantaged)
Dave Ramsey will tell you to pay off your loan with the smallest amount first instead of the one with the highest interest rate. This adds a layer of subjectivity to your personal finance that, while making you "feel good" about paying down your debt, will cost you money. In a recent post, I discuss the financial disadvantages his plan.

Non-tax-advantaged loans that fall into this category include credit card debt, personal loans, and auto loans. Look for your highest interest rate, and start sending whatever extra money that you can to pay it off.

2. Pay off loans incrementally -- don't save your money and pay it off in one fell swoop
I'll give a personal example here. Though I still have a couple of years' worth of payments remaining on my auto loan, I'm hoping to have it paid off by January. While maintaining my "emergency fund" in my checking account, and have been placing my monthly disposable income into an "auto loan payoff fund" that lives in a savings account. Last I checked, I had a few thousand dollars in there.

I had originally planned to keep making my regular monthly payments and continue saving money in the payoff account until I had enough money to pay off the car. But then I crunched a few numbers and found the flaw in my plan. Here's how it goes:

Whenever you make a regular monthly payment on a loan, a portion of that payment goes toward the principal balance and another portion goes toward interest. Those percentages are determined by a couple of different factors:
1) the time left on the loan (the less time left, the higher the percent that goes toward principal) and
2) the amount of remaining principal balance (the lower the balance, the higher the percent that goes toward principal).

So if my monthly payment is $500, maybe $400 of that goes toward principal and the other $100 goes toward interest. Next month, after the principal balance has been slightly reduced, the payment distribution may be $405/95, and so on. But if I have a few thousand dollars in a savings account that's just waiting to be used to pay off the loan, I am better off sending that money as a principal-only payment immediately. If I reduce my principal by, let's say, $5,000, a much higher percentage of my regular monthly payment will go toward principal. If you're paying off a loan on an accelerated schedule, sending the extra money as soon as you have it instead of saving it and sending one big fat check at the end may save you several hundred dollars over the life of the loan.

3) After non-tax-advantaged loans are repaid, evaluate the tax benefits of other loans before repaying them.
Once your credit cards, personal loans, and auto loans are paid off, hopefully all you'll have left is a mortgage and maybe a student loan. At this time, before deciding to accelerate the payoff on these loans, you should reevaluate the stock market. Has it picked up yet? If you're still not feeling warm and fuzzy, do some math and figure out how much your tax-advantaged debt is really costing you.

If your mortgage has a 5% interest rate, remember that depending on your tax bracket, you'll get maybe 25 or 28 percent of that interest back in your tax refund. So think of the effective cost of the debt to be 3.75% (5%, minus 25% of the 5). Your mortgage is a very long-term loan, and you won't see the benefits of paying it down early for a very long time. Paying it off early won't reduce your monthly payments. Sure, it will be paid off sooner, but even if you double your monthly mortgage payment every month until it is paid off, it will take almost 10 years to pay off a 30-year mortgage. If the effective interest rate on your mortgage (the interest rate less the tax benefit) is only slightly higher than the amount you could earn in a CD or a savings account, I would rather see you hold onto that money just in case you need it.

With all loans, especially those that are tax-advantaged, the lower the interest rate, the less sense it makes to accelerate your payoff. My friend Quang's student loan has a 3% interest rate. I wouldn't pay that off early for the world. But the rate on one of my wife's student loans is 7.9%. I can promise you that as soon as my car is paid off, the next thing to go will be that sucker.

Non-tax advantaged debt is nobody's friend. If you're not satisfied with the performance of your investment portfolio, it could be a wise decision to pay it off early in lieu of investing. But if your only debts are mortgages or student loans, think twice before you start sending extra cash toward the principal. True, you're saving yourself money in the long run, but remember that you're also reducing your tax writeoff and parting with that money for a long, long time. And keep in mind: even if you're using the standard deduction (not itemizing), your student loan interest is still tax deductible!

Pork Barrel Spending in Corporations is Equally Appalling

To understand the significance of the downturn in the market, check out Sequoia Capital's Powerpoint presentation on Tech Crunch, which contains a quote near the end that reads "spend every dollar like it's your last one." Though this exaggerates the advice that I offer on this site, it's an interesting principle to consider before you open your wallet.

When you, personally, are fronting the bill for an expense, it's easy to say "no" if you feel like you're overpaying or being frivilous. But when your company is going to pay the bill, you're probably less likely to stop yourself, knowing that you can just "expense it."

Employees in come companies legitimately think, because they're traveling for business, that expensive dinners and hotels and plane tickets and car services and luxury retreats are consumables to which they are entitled. Somehow the fact that the company is going to pay the bill excuses them from making financially sound decisions that are in the best interest of the shareholders. The same goes for over-the-top construction, decorating, and other unnecessary eyes-closed, blank-check spending.

Not all companies are guilty; I actually believe that the company I work for does an excellent job of exercising thrift. However, I find it sad that employees in other organizations that expense extravagant happy hours and meals and hotel rooms are doing a horrible disservice to the actual owners of their companies. All employees of a corporation have an indirect fiduciary responsibility to their stockholders, even if that relationship is separated by many degrees.

It's easy for John McCain and Barack Obama to criticise the government for its pork-barrel spending. Americans hate to see their tax dollars wasted. But the truth is that much of our retirement money lives in corporations. Why do we not hold them accountable for their inefficiencies and outrageous spending (does the AIG $400,000 retreat ring a bell?)?

Every time a client is taken to Morton's instead of Panera; every time a consultant stays at the Marriott Marquis instead of the Comfort Inn; every time a quarterly meeting is held in Las Vegas instead of corporate headquarters, the bottom line is knocked down another notch. And the more corporations whose bottom lines are affected, the more affected are those whose retirement accounts are in mutual funds.

My grandmother has her life savings in her IRA, which is losing money like it has holes in its pockets. I understand that frivilous business expenditures aren't the main culprit that got us into the crisis we're in today, but they're his first cousin. I believe that outrageous senses of entitlement and a complete lack reasonable, responsible financial behavior, on behalf of both individuals and corporations, are to blame.

I welcome and encourage your anonymous comments about outrageous corporate spending that you've seen in your career.

Fixing My Garage Door: D.I.Y.? Or P.A.P.T.D.I.F.Y.?

My wife and I moved into this house in November, 2007. When we got here, I wondered how long we would be able to go without needing some sort of service call. I'm not much of a carpenter, but I try to be a DIY-er (a.k.a "Do-It-Yourself") rather than a PAPTDIFY-er (a.k.a. "Pay-A-Professional-To-Do-It-For-You:) whenever possible. I broke my streak yesterday after nearly 11 months. It was a tongue-in-cheek moment as I wrote a check to Overhead Door Specialists (of Castle Hayne, NC), but I smiled because I was a very satisfied customer.

Imagine the sound of an entire classroom of recently-manicured elementary school students scratching their fingernails across a chalkboard. That's what I heard every time I closed the garage door. And then imagine an invisible Floyd Mayweather, kicking, shaking, punching, and otherwise beating the piss out of a piece of sliding, artistically textured sheet metal. That's what I saw every time I closed the garage door. Operating our automatic garage door became an activity that we came to dread, as it rattled the entire frame of the house and most certainly woke up our neighbors in the middle of the night.

From the interior door connecting the kitchen and the garage, we could reach the button that would open and close the troublesome exterior door. We got in the habit of standing at the interior threshold, pressing the button, slamming the door and running for our lives. Even the closed interior door was no match for the wrath of the metal-on-metal cacophony that hit our eardrums like an eardrum-seeking missile.

In the past, I had successfully addressed every home issue and improvement that I deemed significant and/or necessary. In the interest of saving money, I researched the activities online and performed the work myself. In the past year, I have swapped out a light switch, replaced the kitchen sink, installed numerous landscaping improvements, repaired a fence gate, shimmed a door, changed my own oil, hung floating shelves, and built a fire pit in the back yard that has received numerous compliments from our house guests. But repairing an expensive piece of machinery that boasts scores on independently-moving parts with which I have no experience wasn't something that I was willing to do alone.

Reluctantly, I hopped on Google and looked up the garage door repair place who I had seen at a neighbor's home a while ago. A friendly couple arrived at 5pm in their work truck that was a converted ambulance*. The came inside, greeted me and my dog, and got to work. I told them that I suspected rusty rollers or hinges (If I had done this myself, the first thing I would have done would be to take off all of the hinges and try and clean the rollers, which would have taken at least two hours). I was way off.

Keith, my repairman, showed me how the original door installer, in either the interest of time or habit of laziness, had done a poor job of hanging the track on which the door slides. You could see the professionalism and years' of experience in his face as he expressed his disappointment in the shoddy work of the builder. "They just don't care! They want to be done with it and move on to the next house. 'Does it open? Yeah? OK, we're done!'"

He readjusted the track -- which was a two-person job -- and then put lubricant on the hinges and rollers. He showed me the elusive point of contact that had been creating all of the noise -- a spot that I never would have found on my own. Turns out, it wasn't a roller at all. Because the tracks weren't hung straight, a steel hinge had been rubbing against the steel track, getting worse over time. Imagine a square (the door) in between two parallel lines (the track). If one of those lines is slightly nonparallel with the square, then [noisy] contact will occur. Who'd have thought?

My exterior door opens beautifully now. After they left, I sat in my garage, opening and closing it for at least 10 minutes, enjoying its new-found purr as if it were a selection of inspirational classical music. I reflected on the check that I had just written for $70, happy to have parted with it. If I had been stubborn and unwilling to pay for a service for which I was supremely unqualified to perform on my own, I could have been stuck with permanent damage to the frame of my home (thanks to all of the violent jostling) and/or a broken garage door opener.

DIY repairs can be an excellent way to save some money. But you should also know when to PAPTDIFY (pronounced "pap-defy"). DIY in this case would have put into jeopardy an expensive piece of machinery that I knew nothing about. My first task would have been a total dart throw and a complete waste of time. A poorly-completed repair could have worsened the problem and cost me more money in the long run.

Taking care of your home is important. Repairs will be needed periodically, most of which we can perform ourselves. We shouldn't call a professional just because we're lazy (I still have a hard time watching my young, physically fit neighbors pay someone $30 to mow their tiny .16-acre yards). But if you're tackling a job that is waaaay over your head, call a pro. They'll save you a heap of time and ibuprofen. But when they're fixing whatever they're there to repair, stay out of their way, but close by -- you might learn something!

*Side note: Their work truck was an old converted ambulance that they bought online from a seller out west. Turns out, it was the ambulance that transported the late Ted Williams to the cryogenic freezing lab after his death...at least the "part" of him that made it there, if you know what I'm saying. They call their work truck "The Ice Box."

Tax-Deferred Retirement Savings: Positioning Yourself to Spend Less

In a recent post, I discuss the feasibility of retirement at an early age. The main point of the article is this: the more you save today and the less you can live with after you retire, the earlier you can kiss your job goodbye! But hold on a second...If I'm already sacrificing by saving as much as I can now, how can I be expected to live at an even lower standard of living when I retire? You can. And here's why:

Planning for retirement means more than just putting money into a 401(k) or some other type of retirement account. It also means positioning yourself to withstand many years of little or no income. It means preparing your finances so you'll incur fewer expenses after you retire except, of course, those checks in your grandchild's birthday cards.

In addition to saving for retirement, which will ensure you have lots of money at your disposal, you should also take steps to ensure that you'll have fewer expenses. As I mentioned in my previous post, a 10% reduction in spending each year during retirement could mean the difference between going through all of your principal savings and going through none of it.

So am I saying to head to Costco and fill a couple of industrial-sized freezers with 30 years' worth of food? No. What I am saying is to think about your big expenses. Pay off your house. Pay off your vehicles. Save enough to pay for your kids' (or grand kids') college. Have a tradeable timeshare (or two) paid off.

There are two main reasons to position yourself to have reduced expenses during your retirement:

1) You'll be able to live off less income during your golden years. By reducing the amount you consume each year of retirement, the longer you'll be able to live off of your nest egg. I'm a proponent of reducing debt today so you can save more money. I'm an even bigger proponent of reducing debt so you won't have to pay as much tomorrow when you're certainly going to have less coming in.

2) If you can live off less during retirement, you'll fall into a lower tax bracket. If you work hard to ensure that your expenses will be reduced when you start drawing from your tax-deferred savings, you won't need to draw as much money per year and will therefore pay a lower tax percentage. If today you earn $100,000 per year, you need to pay taxes on all of that money, less your deductions. If when you retire you continue to draw $100,000 from your pre-tax 401(k) each year, you'll pay the same taxes when you withdraw it.

But if you make $100,000 per year today, will you need $100,000 per year when you retire? Probably not. Let's make a few assumptions. Currently, you're saving $20,000 pre-tax dollars for retirement. And you're spending $1,500 per month on your mortgage. And you're spending $500 per month on your car loan. Given these assumptions, your monthly take-home pay will be about $5,000, depending on your state. If you pay off your mortgage and your car prior to retirement, you will reduce your post-tax spending by 40% ($2,000/$5,000). And let's not forget that after you retire, you won't need to save money for retirement.

So theoretically, you could live a lifestyle comparable to the one you had when you were working with $3,000 per month. And if you end up getting social security, you'll need to draw even less from your 401(k); but I don't really believe in social security. So if you drew $50,000 of your pre-tax dollars from your 401(k) annually, you would end up with about $3,200 per month, post-tax -- more than what you had left over after the mortgage and the car payment when you were making $100,000.

Because you're drawing much less, you're put into a smaller tax bracket. The way that you're able to draw less is by making smart decisions while you're working. After you retired, if you were able to cut your annual "salary" in half by living off of $50,000 rather than $100,000, imagine how much less you could live off by "prepaying" even more of your post-retirement expenditures. Want to travel as a retiree? Buy a timeshare or two that you can trade. Need to pay for someone's college when you're retired? Save the money in a 529 beforehand.

People don't spend less during retirement because they eat less or because things get cheaper. They spend less because they have positioned themselves to spend less by paying off their future obligations early, like a home, a car, a vacation spot, and college.

Reevaluating my Rewards Card

I've sworn by my rewards card since the day I had it. But a friend of mine and reader of my site named Steve emailed me the other day to talk up and recommend his own strategy. On this site, I try to be a big proponent of reevaluating our spending and habits, so I knew I'd be a hypocrite of I didn't at least check out his plan and contrast it against my own. Here's what he said:

I've got a schwab account for everyday checking that has the same benefits as the e*trade. Then i automatically send rent/utilities/insurance to a wachovia account and a percentage to a ing direct account for savings.

I use a chase freedom for gas/groceries/utilities for 3% cash back, and I have an Amex that's linked with my corporate amex for everyday expenses that gets points i can turn into airline miles or hotel points.

I've got to say that Steve has a great setup. A benchmark for rewards is about 2% -- anything more than that is tough to come by. And if those rewards are CASH then it's an even better deal.

Before I go any farther, let me reiterate a point I made a couple of months ago and say that unless you pay off your balance in full every month, you shouldn't use a rewards card. They tend to have higher interest rates than non-rewards cards, so in the long run, those rewards might actually cost you a lot of money.

When you're picking out a rewards card, try and figure out what the actual value is of your reward. Cash is easy; points, not so much. If your card offers points instead of cash, figure out how much each of those points is worth in terms of cash and then make your decision. I use my Choice Privileges rewards card, which earns me free stays at Choice hotels. Here's how my points work out:

I earn two points per dollar on everyday purchases that I put on the card. So how much is that worth? I just looked at their online booking system and found a hotel room that would cost $150 per night plus tax if I paid for it, or 6000 points if I used my rewards. To earn 6000 points, I would need to spend $3,000 on everyday purchases (two points per dollar). So if $3,000 in everyday spending gets me $150 worth of hotel rooms, that means that my points are "worth" about five percent of my everyday spending. That's a bit nicer than a one, two, or even three percent cash back card.

I'd say that I travel slightly more than the average American, so I never have trouble using my points whenever I do. Yes, cash back is usually better than points because it has more utility (you're not limited in where you can spend it), but if you can earn twice as many dollars' worth of free hotels than you could dollars' worth of cash, it pays to have the points as long as you would have otherwise paid for those rooms at some point.

Steve also mentioned that he uses his American Express card so he can pool his points with his business expenditures. That's another great idea. Because points are essentially useless until you reach a threshold at which they can be redeemed, it's best to earn them in a place that has more than one "input." A second business card earning you points is a great example of this.

With my rewards card, I don't just earn points from everyday spending. I also get three bonus points per dollar spent at Choice hotels. I travel a lot for business -- sometimes for months at a time -- so these really add up with weekly (reimbursable) bills that often exceed $500. Additionally, these same hotel points can be earned by anyone that signs up, regardless of their method of payment. So Joe Schmo can sign up for an account online, make a reservation, and earn about 10 points per dollar spent, even if he pays cash. This is similar to frequent flyer miles -- anyone can sign up and earn them when they fly, but frequent flyer cardholders earn extra.

So how quickly do my points add up? Let's say that I spend $500 on a room for a weeklong business trip. I'll earn a) the 10 points per dollar that I automatically get for being part of the program, b) the two points per dollar that I earn for everyday purchases on my card, and c) the three bonus points per dollar that I get for spending money at a Choice hotel with my card. That comes out to be 15 points per dollar. Multiply that by the $500 that I spent, and I just earned 7,500 points -- more than enough for a free $150 night.

Choice also runs seasonal promotions that you see advertised on TV pretty often (does the Johnny Cash song ring a bell?). They just finished doing their "triple points" promotion, that will triple the normal 10 points per dollar. Also, because I have spent more than 40 nights at Choice hotels this year, I personally earn four extra points per dollar. So If I spent that same $500 during a promotional period with my preferred status, I would have earned 39 points per dollar, earning me 19,500 points, enough for more than three free nights at a $150/night hotel (assuming 10% tax, that's worth $495). That comes out to be virtually "buy one night, get one free!"

So my rewards card gives me 5% worth of free hotel rooms for everyday purchases. And because those points are going into an account that has multiple inputs, I can use them much faster. Other examples of these types of multiple-input accounts are Airline rewards, which deposit miles into your already existing frequent flyer account, or grocery rewards at specific chains that deposit points into an account that was opened with your little keychain grocery card.

So I'm generally a fan of getting a rewards card that gives non-cash rewards as long as two criteria are met: 1) the value of the non-cash rewards is significantly more than the amount of cash you could get back on a cashback card and 2) the non-cash rewards will be spent on something that you would have otherwise paid for in the future, like hotel rooms, plane tickets, groceries, etc (NOT random crap in an all-points Sharper-Image-like catalog).

As far as my friend's banking choice goes, I have to say that it's a wise one. The 3% interest is high and it has no minimum balance. Today my E*Trade pays me 2.8% on my checking and 3.3% on my savings, with a $5,000 minimum balance on the checking account. Technically, the Schwab account is better than my E*Trade account because it doesn't require a minimum balance. However, I like the fast transfers to my brokerage and IRA accounts that I hold with E*Trade. Though there would technically be value in switching my account, it would be too small to justify the effort of switching.

If you're choosing a rewards card of your own, look for the best offers and try and figure out where you spend most of your money. Use Mint.com to determine this, as they'll tell you how many times you've visited a particular business and how much you've spent there. That'll be a good place to start when determining which rewards card is best for you.

Thanks for your comments, Steve.

Liquidity: The Apples and Oranges of Your Financial Health

It's important to periodically assess your personal financial health. I enjoy using a free tool, NetWorthIQ, to determine my overall net worth. Essentially, the tool works by applying generally accepted accounting principles to your accounts, summing all of your assets and subtracting all of your debts to produce your net worth. It's just like high school accounting where Assets minus Liabilities equals Owner's Equity. Though this tool is useful for numerically and graphically tracking progress from month to month, it can't be interpreted as a realistic assessment of your financial health. Here's why:

All of your assets and liabilities aren't quite as simple as apples and oranges. Some liabilities have tax advantages and disadvantages, and some assets have costs associated with turning them into cash. For example, a student loan and an auto loan may look similar on paper if they have a similar balance and interest rate, but the interest paid on a student loan is tax deductible. $10,000 in a 401(k) and $10,000 in a RothIRA may seem equal, but the Roth money will never be taxed while the 401(k) will be once it's withdrawn.

So when you're determining your financial health, it's important to figure out not just your net worth, but also your liquidity. Liquidity is essentially your ability to turn your assets into cash. I'm sorry to say that these dorky financial terms don't just apply to corporations and accountants -- they apply to you. Think I'm full of it? Consider this:

Some friends of mine bought a house a few years ago for $190,000 and got a zero-down loan. Today, they owe about $187,500 on the place. After a recent life change, they need to move to a different state. Though their house is listed for several thousand dollars more than they paid and now owe, they're still worried about being able to afford to move. According to Zillow, their home's value exceeds what they owe by about $20,000. But when calculating their liquidity, they need to take into account the likely sale amount and their real estate agent's commission, which happens to be an exceptionally low four and a half percent.

Yesterday, a potential buyer offered $195,000 -- $6,500 more than what they owe. But in order to not lose any money, they'll need to sell the house for at least $196,355. The current offer leaves them bringing $1,300 cash to the table at the time of sale. Sure, they could counter offer, but who's to say that they'd ever get a higher offer?

I'm a big proponent of bean counting. It's an important step in the road to wealth. But when you decide to count your money, be sure to do a second analysis that considers only the liquid value of your assets. Obviously, cash is completely liquid. But when considering at your home's value, use a pessimistic market value (depending on how quickly you need to sell) and subtract whatever you would expect to pay a real estate agent. When considering the value of your retirement savings, subtract any taxes and penalties you would need to pay as well as any non-vested employer contributions. When calculating the value of your vehicles and personal property, think about how much cash you would realistically receive for them from a sale.

You'll probably find that your liquid assets are much smaller than your total assets. Though it might not be fun to look at, it's an important truth factor that speaks wonders about your genuine financial wellbeing.

Obama reaching his target demographic with online ads

I'm not necessarily an Obama supporter, but I've got to give him credit; I'm seeing a lot more of his ads than John McCain's. Each politician has a different campaign strategy that focuses on different demographics. One might hypothesize that a democrat would be more likely to target young voters. Based on my recent experience, this is proving to be true.

I'm 25 years old. I don't watch MTV, I'm not in college, and I don't really care for pop culture -- some of the idiosyncrasies you might associate with today's 18-25 demographic. But I can't deny the residing ubiquity of Obama's ads and the comparative absense of ads from John McCain. If Obama is targeting young voters, he's doing a good job. If McCain is trying to not target young voters, he's doing just as well.

Obama is advertising on Facebook, a platform on which my friends and I fulfill most of our communication needs. He's also advertising on Pandora, the music site that I have turned on in the background all day when I'm at work. Traditionally (with as much weight as that term holds given how young they are), these are sites that are visited by net surfers in my youthful demographic.

I wouldn't expect a Republican candidate to spend as much as a Democrat advertising to young voters; young voters tend to lean more to the left. So the purpose of this post is not to discredit John McCain, but rather to credit Barack Obama for being smart about placing his ads in front of my [young] eyes. John McCain's campaign would be wise to be as effectively creative with how it delivers its ads to its own target demographics.

Where else have you seen Obama's political ads? Or are you a target demographic for John McCain? If so, what creative advertising strategies have you seen?