The Balanced Spreadsheet-Financial News, Budget Advice, Debt help, Financial Tips, and other advice

January 28, 2010

The Financial How to series Part IV. How to start investing for retirement

Part I-How to start a budget

Part II-How to get out of debt

Part III-How to start and maintain an emergency fund

Today we are going to wrap up our “Financial how to . . . . .” series on the topic of how to start investing for retirement.  For some this can be a scary topic as it brings up many questions such as “How much do I need to save now for retirement”, “How much will I need to retire”, and “What types of investments do I put my money into.”  These are all good questions that need to be answered before you start to invest.  With that being said I am going to focus on how to get started and not give any advice on certain funds or stocks as I am far from an expert. 

What is investing?

There are three kinds of investment lengths, although as I will discuss later I think only one is truly investing.  There is short-term investing which is less than one year, intermediate investing which is between 1-5 years, while long-term investing is greater than 5 years.  I consider long-term investing the only true investing as the stock market has usually made money over any 5 year period compared to only about 60% of the time over a 3 year period which is more like speculating and as we saw as recently as 2008, investing for only 12 months is essentially gambling. 

Types of Investing

For me there are two kinds of investing, retirement and non-retirement.  Non-retirement includes investments such as a child’s college fund, saving for a down payment on a house, or investing in real estate.  Retirement investing includes vehicles such as 401(K) and IRA’s.  They have special tax advantages to them, but there is a catch as they have penalties for early withdraws, therefore the decision needs to be made ahead of time that any retirement investing is truly for retirement only.  Most of the time when people talk about investing, they are referring to retirement investing which is the main focus of this post.

Common investments

When investing in retirement accounts, there are three common investments: stocks, bonds, and cash.

Stocks are the most common investment as well as the most discussed.  That is because they have the most day-to-day volatility.  Stocks have traditionally offered the greatest reward but also the most risk.  Stocks have been way down after their highs in late 2007.  But in 2009 they have started to make a recovery.  The key to stocks is to diversify by selecting mutual funds that contain many stocks in one fund. 

Bonds have done well recently with the drop in interest rates.  They have less day-to-day change in price than stocks; however they have historically underperformed the return of stocks.

Cash is invested in things such as savings, money market, and certificates of deposit (CD).  They are “safe” investments, as you do not risk losing any principle with the return being a fixed rate.  Investing in cash to me though is an oxymoron because you are parking your money as you might be gaining 4-5% every year but you will lose most of your gain due to 4% inflation so you gain nothing. 

Commodities include things like oil, natural gas, corn, wheat, and precious metals. Commodities are historically very volatile with huge upswings and downswings. 

Things to look for when investing

Whatever you decide to invest in I would recommend you look into the following three things before investing

Diversification You need a balance portfolio and not have all your eggs in one basket no matter how great of a return you are getting.  Diversification protects against losing all of your savings on just one bad investment.  For that reason when I invest in stocks I do not investing in single stocks but rather mutual funds which are made up of various stocks.

Invest in things with long track records You do not want to start investing in something that has only been around for years.  By seeking out funds with at least a 10-15 year track record you can see how returns have been over both good and bad periods and see if they have been able to weather the storm.

Know where you money is going! Invest in things you are comfortable with.  Never put money into something you do not understand as you do not want to be pressured into something that you do not agree with.  Investing in X because “my co-worker said it was a good idea” or because “My brother-in law invests in it” does not mean it is a good idea.

As mentioned in the opening, investing can be trick and overwhelming for a lot of us.  What you need to do though is to take some time and learn about investing.  Finally, building wealth takes time; it is not an overnight process.  But you need to start soon and invest in good solid investments and not some get rich quick scheme.  The key to building a big nest egg is investing now instead of later.  You might be in your 20’s or 30’s and think you have plenty of time which you do, so use your time as an asset and not a liability.  Also if you are in the later years of your life, do not worry, you can still start today.  It is never too late.

That is the conclusion to The Balanced Spreadsheet’s January 2010 “Financial how to . . . . . .” series.  I hope you enjoyed it and we will be back soon with another series in February.

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January 23, 2010

The Financial How to series Part III. How to start and maintain an Emergency Fund

Today in continuing with our January “Financial how to . . . .” series, we will discuss how to start and maintain an emergency fund.  After getting a budget started and knocking out your debt, the next step towards good financial health is the emergency fund

The Importance of an Emergency Fund

From personal experience, I can vouch for how important an emergency fund is.  It will help ease the pain of a sudden layoff by giving you a cushion to cover your monthly expenses until you get re-employed.  It also is a way to pay for unexpected normal life events such as your transmission going out in your car, a big medical emergency, or a broken heater in the dead of winter.

What it is not for

The emergency fund is what it is, a fund for EMERGENCIES!  Sometimes we can get emotional and get caught up in the moment and forget what an emergency is truly.  Normal car maintenance such as getting new tires after they get worn down is not an emergency and can be planned for in normal budgeting.  Home appliances breaking down that can be fixed but instead buying a whole brand new one is not an emergency but rather a want.  There is nothing wrong with buying wants, but wants come out of savings not the emergency fund. 

In addition to not being used for wants, the emergency fund is not used for long-term investing.  This will be discussed more below, but an emergency fund is not something that you take risks with.

How big of a fund do you need?

According to recent statistics from the United States Bureau of Labor, the average American is taking a little over 6 months to find new employment after being let go from their previous employer.  With that major statistic in mind I recommend somewhere between 5-7 months worth of expenses as a good solid emergency fund.  By setting up a budget you can know what your fixed monthly expenses are.  A smaller emergency than 5-7 months does not give you much space or time between some of life’s emergencies.  While on the flip side, an emergency fund up to or greater than one year is excessive to me because the money could be going towards better wealth creation tools such as paying down the mortgage or put in long-term investing. 

Where to keep your funds

As mentioned above the emergency fund is not an investment tool and something that you will be getting rich off of.  First, you are looking to keep your emergency fund somewhere liquid, which means someplace where you can get easy access to your money if needed.   Next, you will then look for something low risk as you do not want to risk losing any principal.  The higher interest rates are tempting but when you really need the money it could be down 20-30% leaving you without an emergency fund.  With all that being said, the best place to put it in is a simple money market account or savings account at a bank.  Right now the yields are pretty low at around 1% but remember this money is for emergencies not investing.  A simple search through either bankrate.com or despositaccounts.com can help you find the best rates available.

What an emergency fund allows

Finally after determining how much of a fund you need and where to place it you can now fully experience what an emergency fund allows.  It will allow you peace of mind at night knowing that you have space from a financial disaster if a financial emergency takes place.  In addition, when these emergencies do occur they will not necessarily be an emergency but rather an inconvenience.  This peace will allow you to concentrate on achieving your greater financial goals.

In conclusion the emergency fund might seem trivial and unnecessary . . . . until you have an emergency that is. : )  Ask anyone who has it in place and they will tell you how it has helped them out.

Next time in part IV of our “Financial How to . . . . . .” series, the topic will be how to start investing.

January 16, 2010

The Financial How to series Part II. How to get out of debt

Today we are going to continue in our “Financial How to . . . . .” series. The goal of this series is to give practical insight on how to get one’s finances in order for 2010. In part I we discussed how to set up a budget and today in part II we will discuss how to get out of debt.

What kind of Debt are we talking about?

I simply divide debt into two types; mortgage debt and non-mortgage debt. When talking about getting out of debt I am talking about non-mortgage debt. While ultimately your goal is to become 100% debt free, I am focusing on becoming non-mortgage debt free because that is something that usually can be done in a short time frame between 6 months to a couple of years. Mortgages, however, are usually one’s biggest debt and take usually 7+ years to fully pay off.

That leaves us today with every other kind of debt imaginable from credit cards, car loans, and student loans to IRS and family loans. Second mortgages can be a little tricky though. Typically if the balance is greater then half your income, I would just treat the debt like a first mortgage and put it on the back burner. If it is less then half I would then treat it like any other debt.

Listing your debts

Now that we have established what debts we are talking about it is now time to start the debt reduction process! First thing you will want to do is list your debts from smallest to largest. Next, after doing your budget you should know how much “extra” money you will have each month, after necessities and fixed expenses, to apply to your debt. Then start making the minimum payment on all of your debts and put the extra money from your budget onto the smallest debt. This is called the “Debt snowball” method. Below is an example that illustrates how this is done. In our scenario the person has $22,400 in debt and four different monthly payments. The minimum payments total $531.25 with $750 of extra money for total monthly reduction of $1,281.25.

Why the lowest amount? Would it be better to pay off the higher interest rate debt first?

From a mathematical stand point the debt snowball is usually the costliest way to go. By paying off the smaller loan first you can sometimes allow greater balance with a higher interest rate to accrue more interest. However I have found that the problem with debt is not the interest rate, but rather with personal behavior and by paying your smallest debt first and knocking it out, you will gain momentum and become more aggressive in paying off your debts then you would if you paid off the higher interest rate but kept more debts outstanding. By changing your personal behaviors you will never go back to debt which will more then make up for the extra interest paid.

After you pay off the first debt

Going back to our example, after three months our student loan would be paid off! After paying off the student loan we would then take the $60.00 minimum payment and apply it to our credit card #1 balance. We would then pay $885 a month on credit card #1 ($75 minimum + $60 student loans +$750 in extra money). After paying that debt you would then apply that payment to credit card #2 and son on. Your debt reduction would approximately look like this:

 

In 19 months you would be debt free!

Exception to the Debt Snowball

There is really only one exception to the debt snowball. That is IRS, State, or local income taxes. Always put them atop of the debt snowball. The reason is simple, the IRS has the ability to garnish wages without actually suing you, and the debt does not go away if you ever have to file for bankruptcy. Couple that with high late fees and interest payments and you will want to get them out of your life as soon as possible.

Conclusion

Getting out of debt is not a piece of cake. It is hard work and a lot of sacrifice but the payoff is well worth it! The debt snowball might seem daunting to you at first, but go ahead and try it, and if it does not work you can always go back into debt. J In our made up scenario 19 months is probably a little conservative. During the 19 months we took to pay off the debt, a variety of positive financial events could have happened such as getting a raise, getting a refund back from the IRS, or tightening your budget even more and coming up with extra payments to make on your debt, which would all decrease your time in debt!

Come back soon for Part III in our “Financial How to . . . . . .” series on how to start and use your emergency fund.

January 14, 2010

Follow up to “Financial How to. . . .” series Part I. Updating our own budget

This is a follow up to my post in the “Financial how to . . . . . .” series on creating a budget.  My very first blog post was on how my wife and I created our very first budget.  With the New Year under way my wife and I have decided to look at our budget and see if any adjustments were necessary and we came up with the following budget.

Budget 2010

You may remember that our household budget is based solely on my income.  My wife’s income goes primarily towards retirement and extra mortgage payments.  With that being said, our budget has stayed pretty much the same primarily due to the fact that there is a salary freeze at work and I have not gotten any kind of raise in two years.  We did track our spending throughout the year and made a few adjustments.

Necessities-The only thing that slightly changed was our gas budget.  The grocery budget is small compared to the average US household, but we are fine with it as we do not feel any restrictions when it comes to going to the grocery store.  I am always trying to find ways to decrease our utilities and we might be a little over budgeted but I would rather be over budgeted then under budgeted.  We are always trying to keep our necessities down to a minimum so it was good to see them decrease slightly.  By keeping our necessities where they are, we are able to keep our emergency fund at $10,000 which is between 3 and 6 months worth of expenses.

Fixed-These increased slightly, due to the fact that our taxes will go up due mostly to me switching from a traditional 401(K) at work to a Roth 401(K).  This was offset by a decrease in car and health insurance premiums for the year.  In July we took out a life insurance policy for me, which was an added but necessary and well worth it expense. 

Luxuries-Our lifestyle has pretty much stayed the same since we have gotten married.  The misc category is the one that fluctuates the most from month to month.  Some months we are a tad over budget and others we are real low.  Even though luxuries are our smallest category at 8.45% we naturally had the most discussion over this category.  Sure it would be nice to go to more sporting events and concerts, but at the price of eating out?  Ultimately my wife and I decided that our breakdown was good and fair to the both of us. 

Well after going through a review of our budget, it was nice to see that we are still living within our original budgets as well as our means.  My sticking to our budget it allows us to continue to follow our financial goals and move forward towards financial independence!

Coming up over the weekend will be part II in the “Financial how to . . . . .” series on getting out of debt.

January 9, 2010

The Financial How to series Part I. How to start a budget

As a New Year is upon us, many people are making their New Year goals and resolutions. In these economic times, one of the more popular goals is to get financially healthy. This goal ties in to a new series from The Balanced Spreadsheet titled “The Financial how to . . . . “. During the month of January I will have posts with helpful hints on how to get started with some basic financial principles such as getting out of debt, building an emergency fund, saving for retirement, and more. Today’s topic is how to build a budget.

I decided to start the series with budgeting because a budget is the first step towards reaching your financial goals. Many people hate using the dreaded “B” word because to them a budget is constrictive or limiting their freedom. However those who do a budget find it more freeing then they imagined and now see it as an essential part of their finances.

How to start

The first thing you will need to do is find a budget format that works for you. A simple budget search on Google or through Microsoft brings up many different templates. I recommend keeping it very basic to start by keeping your categories very broad. For example I just have an entertainment category instead of having a separate category for movies, sporting events, concerts, etc. For those who may not be computer savvy, a basic pencil and paper budget will do just fine.

Determine your take home pay

Next thing you will need to do is determine what your monthly take home pay is. Your take home pay is simply your gross income less what is taken out of your paycheck for things such as taxes and insurance. For those of us who are salaried this is pretty simple as it is the same every month. Those of us who are paid hourly will need to estimate how many hours they will be working for the month and determine their estimated take home pay. The hard part is for those who get paid bi-weekly, because two times a year they get three paychecks in a month instead of two. In this situation, I recommend making a budget based on two paychecks a month and when a three paycheck month comes you can simply use that money to either pay down on existing debt, or if you are out of debt, to save for something special such as a vacation or for Christmas.

Preparing the Budget

After determining your take home pay you are now ready to make your budget! I break down the budget into three main categories: Necessities, Fixed items, and Luxuries

Necessities-Obviously these things are the most important expenses each month and will get paid first in order:
Groceries
Utilities
Housing
Gas/Transportation

I have food first because if you have enough money to do only one thing each month it would be to eat. Next would be keeping the heat and electric on, followed by your housing, and finally your transportation.

Fixed-These are your expenses that stay the same every month. Common examples could include your phone bill, contributions to a 401(K) or IRA, or car insurance. Also included here are any minimum debt payments such as credit card payments, student loans, or car notes.

Luxuries-Whatever is left goes into the luxuries category. This is where the biggest decisions have to be made. You have a finite amount and usually more wants then what you have money for. In the end you have to decide what is more important to you between eating out, buying clothes, going out for entertainment, or any other thing.

Carrying out the Budget

You have now taken the time to setup and prepare the budget and now this is the most important step! Every time you make a purchase keep track of what category it belongs to. If you reach your budgeted amount before the months ends, you are done for the month or you take away from another category. As you go along you will be amazed at how much money you are spending on certain things. It will also get rid of the question in your head “Can I afford this?” every time you make a purchase because you will have budgeted the purchase ahead of time at the beginning of the month.

How to budget with an irregular income

You might be asking what about those on irregular incomes. Those who are on irregular incomes have a little trickier time doing a budget. But by dividing your budget into the three categories you will be able to prioritize what you will spend your money on. Start with your necessities and go down from there in order until you run out of money for that month. Next month start at the beginning and work your way down until you run out of money for that month. Also for those whose paychecks are seasonal, it would be wise to save money in the good months to help cover the bad months.

I hope you find this helpful. For those of you who have never done a budget before it may seem like a daunting task, but just start and you will get better at it as time goes on. When starting out you will make many mistakes and your budget will change a lot until you can get comfortable with your income. That is ok! Budgeting is best when done with trial and error! For those of us who have been budgeting a while this is a nice review

Next week we will continue in our “The Financial how to . . . .” series with, how to get out Debt.

November 9, 2009

What do when you car is Under Water

When people decide they are ready to get out of debt, one of the first things they try to get rid of is their nice car with the big stinking payment of $300+ a month.  However, when they get ready to sell the car they realize that they owe more on the car then what they can sell it for.  This is commonly known as “being underwater”.  Some just assume then that they are just stuck with the car until they can pay it off but that is not true as there are some options one can take to get rid of the car loan.  Below are the steps to be taken to get out from a car loan that is underwater.

  1. Determine what the car is really worth-Sites such as Edmunds and Kelley Blue Book are two good sites to get this information.  Enter your cars information such as make, model, year, and mileage and get a value.  Use the private sale price instead of the dealer price.  The dealer price is what a dealer is willing to give you which is at wholesale, while private sale is the retail price and will be higher then what a dealer can give you. 
  2. Determine how much you are underwater-After determining your cars value, find the loan balance from your latest statement and subtract the cars value.  That is how much you will need to borrow to cover the difference.
  3. Line up a loan for the difference from a credit union or local bank-This is the most difficult part of the ordeal and you will need to make sure this part is taken care of before you put the car up for sale.  Getting a loan through the dealer that you bought the car is next to impossible so your best chance is at a credit union or local bank.  If you have your car loan through a credit union or local bank already then they are probably be your best bet to get an unsecured loan because basically they already have one if the car is underwater.  You might have to go to everyone in town until you find one willing to loan you the difference.  The interest rate will undoubtedly be higher but you will have a loan at a fraction of what you would have owed.  If no credit unions or banks will loan you the money, you can always try and put the deficit on a credit card, although that is as a last resort.
  4. Sell the car-After lining up the loan you are now ready to sell.  When you find a buy you will give the buyer the keys and a bill of sale.  You will then take the money from the sale along with the loan money and send them to the finance company.  You will then receive the title in about a week and you will then send it to the buyer.
  5. Pay off the loan as quickly as possible!-The sooner the better obviously.  You will be more motivated then ever now since you will be paying for something you do not even own anymore!

Real example-So using some numbers let us assume you have $20,000 car loan and after doing some research you find out you can sell the car for $16,000.  You go to your bank where you have your financing and receive an unsecured loan for $4,000.  After selling the car for $16,000, you send in $20,000 ($16,000 from the sale and the $4,000 you borrowed) to pay off the car.  A week later you get the title in the mail and go ahead and give it to the buyer.  All you have left then is a $4,000 loan that will be paid off very soon and will give you the cash flow you need to create wealth. 

Hopefully you will never be in this position, but however if you do find yourself under water on your car, just realize that you can get out with a little patience and persistence.

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