Sunday, May 25, 2008

Ways to increase income

With the expenses of gas, food and other necessities on the rise, it is ever so hard to "save" for some of the luxuries in life. As you may know from a previous post, my overall goal is to be in a position to retire by age 45. However, between that time and now, I would not mind being on par with the Jones's every now and then.

I would like to state that I do not promote or condone living outside of your means because I do believe sound personal finance requires sacrifice. However, if you are willing to sacrifice a little free time, there is no reason that you should not be able to indulge everyone now and then. With this said, I have decided over the last few months that I want to improve my home, purchase a new (used) car and have some other amenities.

Now, currently in my budget, I do not have any money allocated for any of these new "wants". However, I have the following recommendations to get more income:

1. Work Overtime: If your employer allows it, overtime is a great way to pick up extra income. Typically overtime pays 1.5 times your hourly pay which tends to provide much needed income for wants.

2. Part-time Job: If your employer does not offer overtime, however you find that you have extra time on your hands (especially on the weekends), a part-time job could provide more income. One can easily pick up a standard status quo job in retail, waiting tables or even working at a gym. For those who want something a little different, try learning how to DJ or bartend and put those skills to good use.

3. Craigslist: If you are like most people, you probably have some old video games, old purses, old tools or maybe old jewelry that is taking up space. Here is where Craigslist comes into play. It is a site that allows you to post on a bulletin board style site that is anonymous until you respond to the inquiry made for one of your posted items.

Everyone may not be in the position to log extra hours at another (or their current) jobs or sell extra stuff on Craigslist. Another method for getting more income is to reduce current expenditures as listed in a previous blog entitled "Cutting Costs (Part One)". Share with us some of your ideas on how to get more income to obtain some of the luxuries in life.

Monday, May 19, 2008

The Debt Latency Trap

When getting paid with physical checks and purchasing with cash, it's fairly easy to determine how your finances are doing. As long as you successfully anticipate when bills will arrive, and you have enough money set aside to cover expenses, it's not that hard to stay out of debt.

However, with credit cards, things can get a lot more complicated. Here's an example; assume you have the following:
  • A credit card that closes at the end of each month. The December statement just arrived, and shows an $800 balance.
  • A job which pays you $500 on the 15th of each month.
  • A bank account with a $800 balance.

You start off the new year by paying off your December statement completely. You then make a $500 purchase on January 3, a $300 purchase on January 20, and a $400 purchase on February 10. Your bill closes on January 31, and you receive a statement showing $800 owed. You receive your paycheck on February 15, and immediately pay off the January statement. On February 25, you spend $200, and on March 5, spend $600. Your February statement arrives showing $600 owed, and on March 15, you pay it off. What is your current financial status?

Answer: You are $500 in debt; more specifically, your debt is leading your income by a little over a month. Even though you show a $100 bank balance, and you were able to make your payment without fees in January, February, and March, you're still running a $500 deficit, since the total amount of purchases made since January 1 ($2000) exceeds your income since January 1 ($1500).

This issue is due to what I call debt latency. When purchasing on credit, it's very easy to let purchases get slightly ahead of income. Over time, the gap between expenses and income can extend for as much as 45 days without problems, and unless you're consistent about when you pay your bill, you may not even notice. But if something unexpected occurs (Car repairs? Plane tickets to a funeral?), you may quickly find yourself unable to pay your full credit card balance, and suddenly face significant credit card fees.

Here's a step-by-step analysis of what happened. When you made your initial purchase on January 3, you were spending money which was not yet earned. Even though you got paid on January 15, the additional expenditure on January 20 still meant that you spent more money ($800) than you made ($500). The same thing happened in March: only $500 of income was taken in, but $600 of new expenses occurred. The result is that as of the end of February, almost all income through the end of March has been consumed. The March 5th purchase puts you in an even worse position, as it consumed the remainders of March's income, as well as all of April's income. As of March 15, you still have sixteen days until the end of the month: any purchases made during this time will push you over the amount you will be able to pay without fees in April, and even if you arrive at April 1 with no new expenses, any purchases made during that month will still be drawing against May's paycheck. Even worse, the $100 balance remaining in your checking account on March 16 may create the illusion of financial stability. Where did this $100 come from?

Here's where part of the trap lies: Over the course of the example, the date on which credit card bills were paid changed. The December statement was paid using money already in the bank, including December's income. The January statement, however, was paid using January's income, and part of February's. The February statement was paid using the rest of February's income, and most of March's. The expenditures at the beginning of March will use up the rest of March's income, and all of April's income, and if you're not careful, you could find yourself spending into May's income as well (which will result in credit card fees).

One of the biggest advantages credit cards can offer is the 45 day buffer between the time when a purchase is made and the time when payment is due. This buffer gives you more time to earn interest on the money by keeping it in your savings account, and can also make it much easier to handle unexpected emergencies. But remember: credit cards make most of their revenue not from fees charged to merchants, but from interest charged to cardholders. A simple miscalculation, such as paying a bill before receiving a paycheck one month, and paying the bill after receiving the same paycheck the next month, can result in an inability to make a complete payment in the long run.

What's the best way to deal with this? Treat your credit card as a debit card, and never spend money that you haven't already earned. If you do spend more than your income allows for in a given month, reduce expenses in subsequent months to compensate, until your cumulative income matches your cumulative expenses again. Prepare a rudimentary budget so that infrequent expenses (such as car insurance, taxes, doctors appointments) won't catch you off-guard. And finally, track your expenses religiously using appropriate software.

Given the risk, why use credit cards? I'll discuss this issue in my next article. Stay tuned.

Introducing Peter Sahlstrom

Greetings, everyone,

My name is Peter Sahlstrom, and I have been invited by Jonathan to contribute a series of articles about credit card management to this blog. Nearly everything I know about credit cards is based on personal experience, research, and experimentation; over the next several weeks, I hope to define some of the tricks I have used to keep credit cards working for me, instead of the other way around. If you have specific topics you would like to discuss, please feel free to drop me a line.

Sunday, May 18, 2008

Useful Personal Finance Links

So due to my lack of writing a personal finance article this week, I decided that I would like to share my references of inspiration and information. Below are links to the common sites that I use for great information about stocks as well as personal finance advice in general.

Investing in Stocks

Personal Finance
General Finance Information

Protect your Rights as a Consumer

Great Deals on Products

Please share with us some of the websites that you use for your personal financial management. We would love to check them out and add it to our list. Thanks!

Sunday, May 11, 2008

Hierarchical Budgeting

Earlier this week I had a discussion with one of the finance group members. Of course we get to the discussion of personal finances and he asked me how I handled my budgeting. This required a lot of thought due to the fact that I never formulated a method behind my budgeting madness. After some serious thought, I have decided to write this blog article to explain my budgeting principles.

1. Pay off all bills on the day that income is received, not when the bill is due.


One of the critical priorities of budgeting is allocating the money prior to spending it. A huge downfall that I at one time had, was that I would put money aside (logically) for a bill I knew I had to pay and end up spending the money prior to actually paying the bill. I typically forgot about the bill and when the bill's due date rapidly approached, I had to scramble to get the money to pay the bill on time.


To improve this process, I just started paying all my bills on the day I got paid. This simplified things for me because the money was there and my bills were always paid on time. Due to the convenience of the Internet, one can easily log online and check an online statement to see exactly how much is owed on the bill prior to the statement ever being mailed.


In addition to that, one can just as easy log onto their banking site and use the nifty (and typically free) bill pay feature to send a payment to the bill company directly from the bank. I find this to be very convenient as it allows me to avoid fees that some companies charge for paying online as well as postage and a trip to the mailbox to deliver a check. At the initial implementation, I ran into two common problems...

  • What to do if my first check did not cover all of my expenses
  • After I paid all of my bills with my first check, I had to figure out how I would live for the next two weeks until I received my next check.

2. Always have an intermediate savings account at a certain level to provide cushion in between pay periods.


The next step in the hierarchical budget is having a "buffer" account to help through the time in between pay periods. When my first check did not cover all of my expenses for the month, I would take a mini-loan from my intermediate savings account to cover the bills. Also, I could use that same mini-loan to live off of in between paychecks. One of the benefits about loaning yourself money is that you decide your own interest rate to charge for borrowing against yourself. (And yes, you can charge youself 0%).


This particular account is kept with the same bank that I keep my checking with. This was done so there would be no delays when I needed to move money between the accounts. I roughly opened this account with one pay period's salary because I could comfortably pay my remaining bills as well as have enough to live on for the next two weeks. If you need more than an extra pay period to pay the rest of your bills and live off for those weeks, you may want to put 1.5 pay periods in this account.


*Please note: Call your bank to check if they charge fees for not having a minimum savings account balance or for doing too many account to account transfers in a month. Some banks are sneaky and will nickle and dime you every chance they get*


3. Prioritize your accounts to ensure proper funding at all times.


In order for this process to work, I had to stick to the routine to replenish this account to its original level immediately when I received my second paycheck. Any money that I had left over was then divided among different accounts such as checking, emergency savings account, investments, etc. This is great in theory but after I replenished my buffer savings acount, I did not have a lot money left over for budgeting. To improve on my decision making for fund allocation, I had to categorize the difference between my necessities and wants.


4. Divide expenses into categories (Necessities vs. Wants)


In order to help create more money to have after replinishing my buffer account, I had to divide my expenses into necessities and wants. Some examples of my necessities are mortgage, electricity, gas, groceries, natural gas, internet, phone, tv, etc. These things are the most basic "I need to have this for my regular life" expenses that requires regular allocations.


To contrast this, I have my wants which are things like a Roth IRA, Emergency Savings Account, other investment accounts, discretionary, etc. To optimize my money, I had to learn how to justify each expense. My thoughts behind justifying an expense is very complicated and will be discussed in detail in a separate post.


As mentioned before, my way of doing things may not work for every situation. Please share with us some of your budgeting techniques that work for you. As always, Stay Disciplined!

Monday, May 5, 2008

Question about contribution limit for the Roth IRA

"Lack of money is no obstacle. Lack of an idea is an obstacle." -Ken Hakuta
One of our members proposed a question about my latest article requesting clarification on the contribution limits for the Roth IRA. I have researched this issue and to the best of my ability, believe to have addressed his question. Please review the post below for more information about his question as well as my response to it.

Question:
==============================================================
Can you explain the following specification:

Single filers: Up to $99,000 (to qualify for a full contribution); $99,000-$114,000 (to be eligible for a partial contribution)
Joint (Married) filers: Up to $156,000 (to qualify for a full contribution); $156,000-$166,000 (to be eligible for a partial contribution)
==============================================================

Basically, if you are single and make less than $99,000 a year (all income, not just salary), then you are able to contribute the maximum amount for the year (i.e. $5000 for 2008). In addition to that, if you are married and your combined income between you and your spouse is less than $156,000, then you both (separately) can contribute the maximum amount for the given year (i.e. $5000/person for 2008).

In the case that you make between $99,000 - $114,000 (filing single) or $156,000 - $166,000 (filing married), you have to use the following formula below to determine your maximum Roth IRA contribution for that year:

Reduction Factor (Single) - 99,000
Reduction Factor (Married) - 156,000
Reduction Factor (Married filing separate return) - 0

Maximum Contribution for the year = $5000 for 2008

Less Contribution = (((Annual Income - Reduction Factor) / (15,000)) * (Maximum Contribution))

Contribution = (Maximum Contribution) - (Less Contribution)

As usual, I like to provide the numbers, so see the information below for a more detailed explanation:

If Thomas is single and filing his tax with the single designation and he makes 110,000/year, below is how he would find out his max contribution to his Roth IRA for year 2008:

Less Contribution = ((110,000 - 99,000) / (15,000)) * (5000)
Less Contribution = 3666.67

Contribution = (5000) - (3666.67)
Contribution = $1333.33

The maximum contribution that Thomas can make (legally) to his Roth IRA is $1333.33. All of this information used to research this came directly from the irs.gov website at the following link:

Contribution limit reduced
http://www.irs.gov/publications/p590/ch02.html#d0e9412

As always, I want to encourage members of the group (as well as others) to feel free to post questions and give feedback on these articles. I really do appreciate to know that we all are sharing knowledge to help each other make more financially sound decisions. Stay Disciplined!

Sunday, May 4, 2008

So What Really is a Roth IRA, and why do I need it?

"You will never retire on the money you save for retirement; you will retire on the money you make on the money you save for retirement." -Bill Donoghue

So I recently asked a group member the other day if they knew what a Roth IRA was. They stated that they did, so I asked the following question:

"How long do you need to hold on to a Roth IRA before you are able to pull it out tax free".

She told me that you have to hold on it until your retirement age (approximately 60 years) old which partially correct. However, from this short exchange, I realized that most people (me included) understand the key words when it comes to investing, but do not understand the specifics behind those key words. Without a better understanding of these key phrases being thrown around in regards to ones retirement, we could easily make the mistake of not choosing the best vehicle for our investment. This article will hope to educate most people about the Roth IRA.

Definition
Roth IRA: an individual retirement account from which you can withdraw your earnings completely tax free any time after you reach age 59 1/2, provided your account has been open at least five years (Reference)

Possibly the biggest advantage to using the Roth IRA is that it allows you to grow your money tax-free. Yes, TAX-FREE. Let's look at the numbers to better understand how this is a benefit to you as the investor:

Scenario:
Age: 24
Starting Capital: $0
Annual Contribution: $5000
Years to Grow: 31
Retirement Age: 65
Interest Rate: 10%
Current Tax Rate: 25%
Estimated Salary: $50,000

Value at Retirement (Traditional IRA): $2,610,330
Value at Retirement (Roth IRA): $2,683,185

Difference: $72,855

Numbers do not lie and under the conditions specified above, the Roth IRA would allow you to have an extra $72,000 in your pocket at retirement, which is very useful in obtaining that Maserati that you have always wanted. For more information on how this data was calculated, please view the following link:

Financial Calculator (Roth IRA vs Traditional IRA)

For assistance in determining your tax bracket, click on the link below:

Finding out your Tax Bracket

So What's the Catch

There's a saying that if it is too good to be true, then it probably is. Well, in this case, it really is not. There are a few specifications that you must meet in order to be able to participate in the Roth IRA investment vehicle, however most middle class workers meet this criteria:

Single filers: Up to $99,000 (to qualify for a full contribution); $99,000-$114,000 (to be eligible for a partial contribution)
Joint (Married) filers: Up to $156,000 (to qualify for a full contribution); $156,000-$166,000 (to be eligible for a partial contribution)

Another important criteria to explain is that you cannot contribute more than your annual salary. For example, if you make $2000 in one year, $2000 is the maximum amount you can contribute to your Roth IRA for that year. Also, the maximum you can contribute to the Roth IRA in one year is $5000. As you can see, most people fall under these categories and are able to contribute the full amount to the Roth IRA.

Another great benefit about the Roth IRA is that all of your contributions to this fund grow tax free after you have held the fund for at least five years. However, this does not mean that you will not receive an "early withdrawal penalty" if you decide to pull your contributions out prior to retirement. In addition to that, the interest and capital gains that you withdraw from your Roth IRA are subject to a 10% tax if you begin your withdrawals prior to your retirement age (59.5). There are exceptions to this rule which will allow you to pull out Roth IRA distributions without being taxed listed below:

  • Worker has become disabled and can no longer work
  • Distribution for a beneficiary
  • Buy, build or rebuild first home

Roth IRA Distributions

You have the facts, so why not...?

Another great benefit about the Roth IRA is that you are not forced to take the minimum distribution after you have reached age 70.5 as required by the 401(k) and other traditional IRAs. This holds a benefit that will allow your money to continue to grow tax free until you need to use it.

Now that you have been armed with new information about the Roth IRA investment vehicle, I hope you realize that the Roth IRA is a sound investment choice. Now it is time to dive head first to make the compound interest from your investment begin working for you immediately as well grow it 100% tax free! I recommend opening an account with Vanguard or TrowePrice to get started, but you are not limited to mutual funds. Please choose carefully and have fun!

As usual, if you have any comments, please leave them below.

Saturday, May 3, 2008

Cutting Costs (Part One)

With gas prices currently breaking records, everything from consumer goods to food is following suit. At this point, any type of money that can be saved has the potential to have huge benefits in the long run, especially with the current trend that exists. With this in mind, one of our members has written an article with some tips that anyone can use to reduce their overall costs.

With prices on the rise, it is important to evaluate where your money is going and areas where you can cut back on spending. There are many things that you can do to stretch your dollar that will have a small impact on your lifestyle.

Entertainment

  1. Buy an entertainment book. They are about $15 to $20 initially, however they contain coupons to place that you would probably go anyway and will pay for itself quickly. This website has reduced 2008 books to $9.99 (Atlanta Entertainment Book)

  2. Get books for free from the library. You can also get DVDs there.

  3. Save money at the movies by going to the matinee or waiting a bit and going to a dollar theatre.

  4. AtlanTIX has same day half price tickets to theatre, dance, music and cultural attractions.

  5. The High offers free admission to Fulton County residents the first Saturday morning of every month.

  6. When you are eating out, just drink water with your meal. It is free and it is healthier.

Household/Car/Utilities

  1. Replace incandesacent bulbs with CFLs (fluorescent lights). The initial cost is more, however they last for about ten years and save about 75% in energy.

  2. Walk if possible.

  3. Turn off lights and appliances when you are not in the home. Also pay attention to phantom load, which is the electricity consumed by appliances when they are off but plugged in. I have heard that having the TV plugged in but off is almost equivalent to leaving it on all day (can’t confirm how true that is). To avoid this you should use a smart strip.

  4. Buy energy efficient appliances.

  5. Drive your car for as long as possible, especially if it is paid off.

  6. Use Craigslist or go to garage sales.

  7. Re-evaluate your cell phone and cable packages. Check to much sure you are actually using the amount of minutes you are paying/watching the extra channels you are paying for, etc.

Shopping/Food

  1. Buy the Sunday paper and cut out the coupons. You can also get coupons on-line like www.couponmom.com .

  2. Make list prior to going to the store and stick to it. It is easy to start buying random items at the grocery store, so go on a full stomach and only buy what is on the list.

  3. Bring your lunch to work every day and make dinner at home.

  4. Pay attention to how much things cost, so you know when you are getting a good deal. Just because something is on sale does not necessarily mean it is a deal.

  5. Use the unit price on the price tag to compare between different brands.

  6. If you know use a large quantity of a particular item and it will not expire, then buy the larger bottle or load up when you find a really good deal.

  7. Buy the store brand if you can. Most of the time you can’t even tell the difference, especially with medicine.

  8. Don’t waste money on buying fancy toilet paper and paper towels. It is literally money going down the drain.

  9. Rather than buying bottled water, just buy a filter and re-fill a water bottle.

  10. Most items at the mall almost always go on sale, so before you buy it think if you really need it right at that moment. If not just go back in a couple of weeks and it will more than likely eventually go down in price.

  11. Before you buy anything, take a minute to think if you really need it.


While these small items can add up to larger savings, the place where big savings can come are your car and home. In general, don’t get caught up in trying to keeping up with the joneses and having the latest and greatest of everything. Most people that have that stuff can’t afford it to begin with, so you take what others are doing with a grain of salt.


If you read books, such as The Millionaire Next Door, it has been shown that most self made millionaires don’t buy the most expensive car and live in mansions. They just live modestly and beneath their means and make practical decisions with their money. Although you may be able to afford a larger home, it is important to consider that with a larger home comes the need for more furniture, utility bills, and upkeep all which equal more money.


The same goes with a car. It may be trendy to drive certain cars, but it may not be practical to drive a car that gets 15 mpg when gas is 4 dollars a gallon and you commute to work every day.


As usual, if you have any comments, leave them below. Stay disciplined!