Managing the Finances of a Two-Income Household

Before I got married, I had been warned that money was the root cause of many marital disagreements. My wife and I hoped that we would be exempt from this trend, noting our comfortable individual salaries and modest tastes. Each of us is good with money and we had no problem agreeing to share it 100% from day one. But we didn't realize that merely sharing money with your spouse, even without financial difficulties, can sometimes prove to be a challenge.

So what's so hard about sharing money with another person? If you can each afford the things you want on your own, how does bringing in another person with his or her own income affect this? I can tell you from experience that joint checking accounts will sometimes test you. In a couple that carefully manages their finances, one may feel controlled by the other, like he or she can't spend a dollar without first asking the other. Or a person risks being sneaky by making a large purchase without a spousal consultation.

Sentiments of control or sneakiness can also be amplified by factors outside of spending, like differences in salary, the number of hours worked each week, or even the amount of chores that one does around the house. If a wife makes more money than her husband, she might feel entitled to spend more than him. Or if she feels like she does more around the house than her husband, she should be able to splurge without first consulting him because, hey -- she earned it. On the other side, the husband, though he makes less money than his wife, might work more hours than she does in a given week. Therefore, he justifies spending money on an expensive leisure item -- maybe a boat or a case of expensive beer.

When we are single, we choose to reward ourselves for varying reasons. We might reward ourselves for something big, like getting a high-paying job, or for something smaller, like finishing a long 60-hour week at the office. These are habits that we probably developed as bachelors and bachelorettes and it's easy for them to be part of the package when we promise to have and to hold and till death-do-us-part. But once you're married and have checks with both of your names on them, it's easy to disagree with the other's spending habits. The good news is that there are a couple of simple things you can do to help ease the transition.

#1 - Talk about money regularly, but only at established intervals
If your wife comes home from the mall with an armload of shopping bags or your husband walks in the door with leftovers from Outback, it's easy to call him or her out on it. "Hey, didn't you just buy new clothes?" or "Hey, isn't steak a little out of our budget?" The opportunities to micro-manage your partner's spending are limitless, but they should be avoided because they can give the impression that you're being controlling.

What I suggest is this: Only review your budget and spending at established periods -- be they weekly, bi-weekly, or monthly -- and not in-between. As you know, I am a huge proponent of using free online personal finance tools, such as Mint.com. Mint has a feature that will email you every Friday with your account balances and month-to-date adherence to your budget. And it gives you the option to send the message to two email addresses. So each period, you and your spouse should look at those items together and note any flags. "Hey, we're way over budget on restaurants this month -- we should start eating in more," or "I've already spent $300 on clothing this month. Maybe I should hold off on another shopping spree for a while." These regular reviews will help prevent micro-management of each others' spending while allowing the two of you to stay on top of your finances as a whole.

#2 - Establish a $100 rule
Call it whatever you want to call it -- the $50 rule, the $100 rule, or the $500 rule. Establish a spending threshold that will constitute a required consultation with your partner. If you have a $100 rule, any time one person is going to spend more than $100 on anything, the other needs to be consulted. You can bypass this by setting up spending limits for trips. For example: "When you're in Pittsburgh, don't spend more than $200." Again, this is a rule to help alleviate sentiments of one controlling the other's spending while ensuring that the couple's financial goals are on track.

It's easy to have be critical of your partner's spending -- especially if you do more around the house, work longer hours, make more money, etc. But if you two have decided to pool your green, forgive the expression, but you'll have to put your money with your mouth is. Check your grievances at the door and manage your finances as an individual with two jobs. Play nice, don't micro-manage, and consult one another on large purchases. Active or passive aggressiveness won't cut it.

How do you and your significant other share finances?

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?

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.

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!

Prosper.com: Convincing My Wife, Part 2

...she ain't convinced yet.

In my continued efforts to convince my wife that Prosper.com is a good investment, I'll analyze another aspect of the website today. Today I'll study what makes the successful lenders successful, what makes the average lenders average, and what makes the biggest losers, well, the biggest losers. I'll be moving my analysis platform to a fabulous website that focuses solely on Prosper.com lender and loan data, EricsCC.com.

To get things moving along quickly, consider the following graph that shows all lenders' rates of return on a seemingly normal distribution curve (please click any graphic to enlarge it):
As you can see, the majority of lenders are making money, and a significant majority are also earning a higher rate of return than they would earn in a traditional savings account. However, of all the non-average lenders, there are more that are doing exceptionally poor than doing exceptionally well. This indicates that if you do not follow a reasonable, disciplined investment strategy, you are more likely to lose at a high rate vs gain at a high rate. I guess the same could be said about the stock market. Essentially, it's easier to make mistakes than it is to get lucky.

Do you ever watch that show called The Biggest Loser on NBC? Well meet the biggest loser on Prosper.com: scoobydoo. Here is a graphical representation of his investments:
As Antonio from the Merchant of Venice would say, His "ventures are in one bottom trusted." This guy has invested a lot of money into Prosper.com and has given several large loans to people with C-grade credit. If one or two of those loans defaults, his ship will have sunk.

Let's look at another big loser's profile. How about jasonpeery:
Here's another guy that has a poor, lazy investment strategy. He has invested over $50,000 in Prosper.com listings and has scores of late payments and defaults. This guy has made several individual loans over $1,000, including one that is in default for $11,000! Why in the hell would you EVER loan $11,000 to a person with high-risk credit? And without even asking them a question! I sure hope that jasonpeery is better at personal finance than he is at determining to whom he should lend his money. As Neil Boortz would say, I bet that this guy has a lot of rent-to-own furniture in his house. My guess is that this guy's grandmother died recently and left him a bunch of money. No one that worked for $11,000 and saved it would ever be that careless in giving it to a single high-risk stranger.

One thing to remember about Prosper.com's fee structure is that all individual loan fees are passed along to the borrower except for a 1% loan servicing fee which is paid by the lender. This means that, statistically speaking, there is no reason to invest more than $50 in ANY candidate. Period. If I lend $500 to one person or $50 to ten people, I will pay the same loan servicing fee. And though I may save a little time by investing more money in lower-risk candidates, it's just plain silly to not diversify to the max with sub-prime borrowers.

OK, so let's look at someone with an average return. Consider the portfolio of helpishere777:
Ahh, this is refreshing. This user is right in the middle. He is earning about 11% interest, which takes into account the probability of his late payments going into default. He has invested the same $50,000 that our last big loser had invested, but in a completely different way. Look at the nice even relationship between all of the blue and green lines. Do you know why they're all equal? Because he invested the same $50 into every single loan. He understands that in order to mitigate his risk, he needs to diversify -- especially if he can do it at no additional cost!

Now let's look at the best lender. I'm not going to evaluate the person earning the highest return on his money. Currently that person is DrakeCO, who is earning about 33.6% interest. However, the average length of his loans is less than one month and most of his loans have been large amounts (max of $1,500) to high risk borrowers. Because of the youth of his loans and the nature of his strategy, he is bound to fail. Instead, I'm going to look at someone earning about 20% return with a reasonably large average loan period (if it's not old, the borrowers don't have time to be late!) and a significant amount of money. It looks to me like the golden child of Prosper.com is brother_tam. Here is his portfolio:

brother_tam is obviously smart and probably a little lucky. He has invested a little more than $10,000 in Prosper.com, mostly in $50 increments. Of his 224 loans, he has given more than $50 only 13 times, probably just to spice up his account. As a lender that understands the need to diversify. He is aware that he can invest in lower-credit borrowers because of his discipline. But he doesn't invest in only low-credit borrowers. He has a nice normal distribution of his loans that has a mean slightly on the low-credit side.

To be a successful lender on Prosper.com, you need to stick with a disciplined strategy that is formulated around the values of diversification and a normally distributed loan strategy. When choosing which loans to bid on, consider your current portfolio and establish a quota. "Right now, 75% of my loans are to high-risk borrowers. I should invest in some low-risk borrowers."

Remember: there is no penalty for investing the minimum amount in a person. And with more than 2,300 active listings, you shouldn't run out of people to lend to.

If she's still not convinced, I'll have to write more tomorrow.

Setting long-term financial goals

I've been a long-time proponent of creating a budget and setting short-term financial goals. As a recent escapee of credit card debt, short-term goals have been the best tools to dig myself out of that hole. But during dinner last night, my wife and I were talking a little bit about our retirement and I realized that I had no idea when we could retire. All I knew was that we make decent money, don't waste too much on frivolous things, and try to pay cash for as many big-ticket purchases as we are able. Given our current situation, can we retire at 65? 60? 50?!?!

Because I'm no expert, I won't try and tell you how specifically to plan for your retirement. But I will share some results of exercises that I've been going through this morning. Ideally, I'd like to retire at age 50. And according to some initial calculations, I'll need to save a significant percentage of my income to retire at that age, assuming that I do not receive any social security. Of course, my lifestyle during retirement will affect the amount of money that I need to save. Assuming the following lifestyles (% of my current annual income, adjusted for inflation, that I would like to withdraw during each year of retirement), I will need to save the following percent before tax (assuming 8% growth before and during retirement):

• 70% of income: 32% savings
• 80% of income: 37% savings
• 90% of income: 42% savings
• 100% of income: 46.5% savings

Of course, those numbers assume that I will retire at age 50 and will receive no social security (mainly because the system is in the toilet and I don't want to rely on it). If I assume that I will receive social security benefits, my income/savings percentages change significantly:

• 70% of income: 23.5% savings
• 80% of income: 28% savings
• 90% of income: 32.5% savings
• 100% of income: 37.5% savings

One important thing to consider about these numbers is that they all reflect the minimum percent savings required to ensure that the money won't run out by age 90. Each percentage will result in a near-zero balance by age 90. However, by saving approximately 4% more than the minimum savings percentage required for my desired income, I will be able to draw from the account annually without decreasing the principal balance. Essentially, by saving for an 80%-income lifestyle and actually living a 70%-income lifestyle, my account balance will continue to grow indefinitely. Assuming that I save enough to live off of what is today $42,000 per year (70% of 60,000), saving an extra 4% annually will give me an account balance at age 90 of about $1.5 million. Not saving the extra 4% annually will leave me with a balance by age 90 of about zero dollars.

What I have learned from my research is this: I should figure out what kind of annual income I would like to have in retirement. Next, I'll save enough to make that goal, plus at least an additional 4%. It is that relatively small extra savings that will determine if I die rich or poor.

Healthy spending series: Part 2 - Make a plan and stick to it

Continued from yesterday's post...

2. Make a plan and stick to it

This includes financial planning at all levels, from creating a budget for both spending and saving, always making a shopping list (hence, avoiding impulse buys), and establishing some long-term goals. Let's break it down one-by-one.

• Creating a budget will probably be your first step toward achieving your financial goals. When I was getting out of debt, I had to figure out what I needed to pay no matter what (like rent, utilities, groceries, etc), what I expected to pay for other miscellaneous things (including some fun stuff -- no one wants to live in the stone ages), and how much I'd have left over to contribute to debt. Once I realized how much I should be able to contribute, I sent that same extra $500 a month every month like clockwork, treating it the same as I treated my rent. It was only with planned discipline that I was able to eliminate $9,000 debt in less than a year.
  
  Creating a budget and getting to know it will guide your spending every day. Start with the essentials, and then with the non-essentials, and find out what's left to save. If you're not happy with the amount, adjust your non-essentials. Mint.com provides a nice interface to enter your monthly budget goals and has a reporting feature to show you if you're on pace to meet those goals.
  
  See also my post on the benefits of creating a simple budget.
  
  
• Making a shopping list before you go grocery shopping is important. Or if you're shopping for something else, make sure you know what you're out to get. If you're on a random, just-for-fun shopping trip, establish a spending cap ahead of time.
  
  Avoiding impulse buys is an important part of adhering to your spending goals -- even if you've spotted a good deal. Just because the DVD player is 50% off doesn't mean you need to buy it. After all, do you really need another DVD player around the house? If you hadn't been planning to buy a DVD player, you didn't save 50%, you wasted 50%.
  
  Of course nobody's perfect, so plan ahead and give yourself some leeway. When creating your monthly budget, budget some fluff money that you can use for whatever you want. That way, you can make a few of those irresistible impulse buys without as much guilt -- or at least with more predictability.
  
  
• Establishing long-term goals can be tricky. And I'm certainly not a licensed professional qualified to give you advice on how to save for retirement. If you feel like you need help, seek professional advice, preferably from a fee-only financial planner.
  
  Still, it's important to know the basics: The younger you start saving, the better. And the more you save when you're young, the better. If you're older and haven't started saving, you've got some catching up to do.
  
  Save for things other than retirement, like college and the purchase of a big-ticket item. If you own your car and don't plan on buying one for a few years, start making monthly 'car payments' now into a savings account so you can pay cash when it comes time to buy.
  
  Always keep an eye toward the future; understand the basics; don't invest in anything that you don't understand; know that unexpected things will come whether you like it or not.

Tomorrow on tepom.com, the Healthy Spending Series continues with Part 3: Finding leisure activities with income potential or the ability to further your career.