Debit versus Credit

A Look Back At 2007

It’s hard to believe that the New Year is almost here. Christmas has now come and gone (along with Hanukkah) and we’re fast approaching the end of the year 2007. For me 2007 was a great year. I began truly getting my finances in order and building wealth. I’m by no means wealthy at the end of this year, but I am a step closer to achieving my goals. How did you do? Can you look back at the past year and know that you did well with your money? Did you begin an emergency fund (or completely fund an existing emergency fund)? Did you pay down any existing debt? Did you invest any excess money in the stock market or any other financial markets? What sort of returns did you make on your money this year? If you are the type of person who likes to own individual stocks, which companies did you purchase and how did they do? What sort of returns did you make on your retirement accounts? All flavors apply here: IRA’s, 401(k)s, 403(b)s, Roth IRA’s, SEP IRA. How did you do? If you didn’t have a retirement account at the beginning of the year did you start one and fund it this year?

I realize that I’ve asked quite a few questions, and honestly I could probably ask even more, but I think that’s good enough for now. I really want to know how you all did with your finances this year. I want to know, and I want to encourage you to do even better in the upcoming year. Will you do this? I hope so. I definitely plan to.. I know I’ve still a long way to go before I reach my ultimate goal of financial independence. Enough chatter though, let me highlight some of the goals and things that I did with my finances over the course of the year 2007…

At the beginning of the year 2007 my wife and I began a short-term savings account to save up for expenses such as college tuition, vacations, and a down-payment on a house. About midway through the year we expanded our savings by creating an emergency fund money market account. We have been funding this account with $250 every single month. We also opened a mutual fund (investing in gold and other precious minerals & metals) and a brokerage account. As of the time of this writing we have managed to accumulate between these four different accounts about $7,500 dollars. Most of this I money I prefer to think of as long-term, but it’s a start and it’s a cushion just in case we ever face an emergency.

We did pretty well this year I do believe. I want to do better next year, and I think we can. I also want to start focusing a little bit more on saving for a house, and also our retirement. I plan to open and fund an IRA for both my wife and I this coming year. So again I ask, what did you accomplish this year with your finances?

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December 26, 2007
The State of the Housing Market

Unless you’ve been asleep for the past year, you are more than aware of the slump in the housing market. You might be someone who is adversely affected by the downturn in housing, or maybe you are waiting for the downturn to continue because you are looking to buy your own property. My wife and I are in the second situation. We don’t own a house. We are renting and waiting until the best time to buy. Many people are saying that now is the time to buy; housing prices are at their lowest for the past few years, and interest rates are dropping. I disagree. I don’t believe we’ve reached bottom yet. In fact I am unsure that we will even reach bottom in 2008. We may, but it is no sure thing. I’d like to talk about two of the reasons that we are having this downturn in the first place, which will (hopefully) teach us a few lessons about what NOT to do when looking to purchase a house.

A Little Bit of Recent History

The median home price during the year 2000 (this is a national median price) was $119,600. By the fourth quarter 2005 the national median price was $213,900. This is an increase in the national median home price of roughly 178%. The Arizona median home price in 2000 was $121,300. By the end of year 2005 in Arizona the median home price had accelerated to $286,825. This is a 236% price increase. Why are these increases so large? What was going on with the rest of the economy at this time? Most of you will recall the market downturn and the “recession” at the turn of the century. The so-called dot-com bubble burst losing investors billions of dollars and pushing our economy into a soft recession. The federal reserve (public enemy number one, IMO) “fought” the recession (which by the definition of recession wasn’t even a true recession) by lowering their federal funds rate (the rate at which financial institutions lend one another money) 11 times from 6.5% to 1.75% over the course of a few years. These extremely low interest rates are what enabled banks and other financial institutions to lend businesses and individuals money at subsequently low rates.

The Next Pie in the Sky.

Where do investors put their money when their “sure” investment loses them money, and they are forced to pull out? In the next “sure thing,” of course. After the fall of the dot-com bubble and as the fed (aka the federal reserve) lowered their federal funds rate to a ludicrously low amount, investors decided that real-estate was a “sure thing,” and they pumped their money into the real estate market. Of course with this hefty increase in demand homeowners and homebuilders started rapidly increasing their selling prices. Simple economics right? Truly it is. What these investors (and even regular old Joe homeowners) did not think about is that the demand they were creating for homes was unsustainable. What goes up must come down. It’s a law… one which people tend to forget about every single time the next big investment comes around. “It won’t happen to this one,” they say. It always does.

Buying on Expectations

Foreclosures on homes happen. People lose their jobs and can’t afford their home payment anymore and so they end up foreclosing on their home. It is inevitable to a small degree. The level of foreclosures nowadays though is much larger than that small inevitable percentage. Another problem with today’s housing market is that consumers bought their houses on expectations. Expectations that the loan rates would stay low, expectations that they would get that raise next year, even expectations that housing prices would continue to accelerate at the level of growth that they experienced in the early part of this decade. These expectations are foolish to depend on. Purchasing a home will most likely be the largest, most expensive and most important purchase that one will ever make. Making such a large decision while making so many assumptions about the future is foolish, and it is primarily the cause of the increase in foreclosures we’ve been experiencing lately.

I mean no harm and no offense. There are many people out there who are suffering due to the events in the housing market over the past six or seven years. I do not mean to promote that suffering. I only wish to educate those who have not yet made these mistakes, so that they will be able to avoid them. Everyone makes mistakes. We grow by learning from (and not repeating) these mistakes.

The capital one credit card as well as the visa credit card are one of the few credit cards that accept credit cards for bad credit too, on the basis of a clean record.

December 11, 2007
The Automatic Millionaire: Ch 3 & 4
Today’s Friday Book Club will feature chapters three and four of The Automatic Millionaire which was written by David Bach, the New York Times Bestselling Author of Smart Couples Finish Rich and Smart Women Finish Rich. The third chapter is entitled ‘Learn to Pay Yourself First’ and the fourth chapter is ‘Now Make it Automatic.’ I think these chapters go hand in hand, and that is why I’ll be reviewing and covering the both of them in todays’ Friday Book Club.

Learn To Pay Yourself First

David really touches down in this chapter about why learning to pay yourself first is probably the best and most sure way that one can become wealthy. One of the first things he mentions in this chapter is that you should throw your budget out the window. Now while I don’t necessarily agree with completely getting rid of a budget, I do believe that creating a strict budget and sticking to it is one of the more difficult and more stressful way to create wealth. His point is instead of budgeting every little dollar, pay yourself before anything (or anyone) else. This way the only money you have to live on is what is left after all of your taxes, deductions and your money spent on paying yourself first. A great idea, if you ask me.

I want to touch on a topic that David brought up in this chapter. He brought up a list of a few ways that one can become rich in this country. While the list is not comprehensive by any means, I do feel that it is important and relevant to bring up in today’s discussion. I’ll go ahead and list it for you now.

Win it

Marry it

Inherit it

Sue for it

Budget for it

OR

Pay Yourself First

What do you think? Of course winning it would refer to winning the lottery or gambling of some sort. Not a very reliable method is it? Unfortunately a large portion of people in this country feel that winning the lottery will be the only chance they’ll ever have at becoming wealthy. They don’t realize that becoming wealthy is not something that is out of their hands. Indeed it is quite the contrary; the road to wealth and financial independence is a path that must be laid out by the person searching for the wealth. If they do not, the wealth will not mean much, and will probably do them no good in the long run. Think about it for a second. Wealth is in YOUR hands. Not mine. Not your parents. Not your significant others. It is in YOUR hands to become wealthy. It is in YOUR hands to manage your money, and make it work for you.

How do you do this? Honestly… it’s easy. Pay yourself first! Contribute to your retirement accounts. These are tax advantaged accounts which allow you to avoid paying taxes on a portion of your money until you retire. If your employer does not offer a retirement account then start your own (In the form of an IRA or Roth IRA)! Again, this is not difficult, and it’s even easy to set up automatic payments into these retirement accounts.

Now Make It Automatic

I like the way that David describes the importance of this step, and I’ll quote him for your reading pleasure. “There’s no getting around it. In order for Pay Yourself First to be effective, the process has to be automatic.” Truer words might have never been spoken. Most people just don’t have the discipline to pay themselves first every single month unless the process is automatic and out of their hands. Please do not take this advice lightly. Make the process automatic and you will thank yourself later.

Using your retirement plan at work is an easy way to make the process automatic. If your employer offers a retirement plan and you are not already enrolled in it, then drop everything until you have enrolled. Most employers will match your contribution up to a certain amount, which gives you an automatic return on your money. Where else can you get such easy money? For more information on 401(k) accounts (the traditional work retirement plan) follow this link to Are You Ignoring Free Money.

Another way to create a retirement account and make the process automatic would be to open up an IRA account and then set up automatic transfers into this account. Ask your bank or credit union if they offer IRA accounts, but make sure that their accounts offer different investment options other than just a set savings rate or cd rate. You want to retire wealthy right? You won’t build wealth by investing in 2 to 4% savings and cd accounts. Ask about how you can invest your retirement in mutual funds and other higher-yielding accounts. Another place you might go to inquire about an IRA or Roth IRA would be a brokerage firm such as Vanguard, TD Waterhouse, ING Direct, Sharebuilder, or Merril Lynch.

A Quick Overview

These chapters cover a lot more than what I’ve just mentioned and go more in depth with some numbers showing you how much even $3,000 a year can net you over the course of forty years. It’s amazing how much wealth you can build with such a small investment, it truly is. Please if you have learned anything from todays’ Friday Book Club, apply this to your life. Open a retirement account if you don’t already have one, and then set up automatic payments. You’ll thank me, you’ll thank David Bach and most especially you’ll thank yourself.

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December 7, 2007
Facing That Number

A reader of Debit versus Credit recently left a comment on The Worst Years of My Financial Life. She mentioned that she is glad she is not the only one facing bad financial times and proceeded to talk about a few of the things that were weighing heavy on her financial freedom. She has been without work since August, lives on unemployment and has over $17,000 dollars in credit card debt. She is a single mom with two children and is struggling to get by on her unemployment checks. Every single morning she has to face that number: the amount of credit card debt that she has. She asked in her comment if I could provide any advice for her.

I do want to start out by saying that I am not a licensed financial adviser; in fact I’m still just a kid trying to learn about the world (I’m only 24). Nothing I suggest on this site should be taken with the same level of confidence as if it were coming from a certified financial planner. However I do consider myself knowledgeable about the way the world of finance works, and I do have a background in banking which has really helped me to increase my knowledge on the ins and outs of the financial world.

What Would I Do?

With that being said I’d like to voice my opinion on what I would do if I were in this womans’ position. I don’t have all of the facts and I have made efforts to contact the reader who left this comment, but have had no luck in so doing. If you are reading this post then if you could supply any additional information about your financial situation (e.g. monthly income, expenses, etc.) then that would be helpful.

If I were in this readers’ position then the first thing I would be doing is looking for ANY job that pays more than my unemployment does. Unemployment pays next to nothing as I’ve recently been made aware of, and even if I had to take a job which was far below my skill set to increase my monthly income I would do it. I would then take the difference between what I was earning on unemployment and what I am earning with this low-level job and apply it directly to my credit card debt. Meanwhile I would continue to look for a higher paying job, one which would further allow me to pay down this debt. If it came down to it and the credit card debt just could not be easily payed down every month I would consider contacting a non-profit debt management company such as Take Charge America. Of course lastly I would find creative ways to decrease my expenses. If I were paying for something that I could survive without then I would immediately drop it (for example a car if work were close enough to walk or bike to, or cable television, etc).

Facing That Number

Facing that number is never an easy thing to do. I know, I’ve been there. However it can be done. It can always be done. There are always ways to increase income and decrease expenses. No matter how desperate the situation is it is important to not lose faith and to continue moving forward. You’ve heard the old adage, “A penny saved is a penny earned.” In the case of credit card debt it is actually “A penny paid is two pennies saved.” Please do everything you can to apply extra payments to your principal. You will save yourself tremendous amounts of money on interest payments and eventually secure yourself a place in a world where you have no credit card debt. Hang in there.

Does anyone out there have any advice for our reader, or maybe any personal experience with this subject?

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December 5, 2007
The Automatic Millionaire: Chapter Two

Today’s Friday Book Club will feature chapter two of The Automatic Millionaire which was written by David Bach, the New York Times Bestselling Author of Smart Couples Finish Rich and Smart Women Finish Rich. The second chapter of The Automatic Millionaire is entitled ‘The Latte Factor’ and focuses on an idea of David’s (which he dubbed ‘The Latte Factor’) which in a nutshell says that anyone can save money by watching their unnecessary expenditures, such as a morning latte at Starbucks, which could be replaced with homemade coffee at a fraction of the cost.

The Latte Factor

In the early parts of this chapter David explains how he coined the phrase “The Latte Factor.” He was teaching a four-week investment course years ago when one of his students spoke up and told him that his ideas were unrealistic and not really feasible in real life. David, being somewhat offended by this remark, asked the woman to explain. She said that it wasn’t really possible to save 10 dollars a day, that she was living paycheck to paycheck. David called her out on this and asked if she would play along and walk him through a typical day with all of her expenses. She has no problem with this and they begin his little game. It turns out that this woman spends over ten dollars before she is even through her work day! Of course we all have these bad financial habits, whether it be for a latte from starbucks or a pack of cigarettes or maybe even a bag of chips from the vending machine every day. These little expenses can add up quickly. As David puts it a latte a day (at $3.50) adds up to roughly $1,260 over the course of a year.

What That Latte Really Costs

After David covers how these small-item spending habits can cost us thousands a year he works some numbers and figures out how much this woman that he had been talking would be able to save over the course of 42 years at a 10 percent return if she cut down her daily spending habits and saved $5 a day, which is about $2,000 dollars a year. If this woman would do this simple act she would be able to save close to 1.2 million dollars by the time she hits the young age of 65. It sounds amazing doesn’t it? This is one of the reasons that I wanted to start this site, and why I am reaching for a target twenty-something audience. Compound interest (which means earning interest on your interest) is a powerful force. I believe it was Einstein who said it is the most powerful thing in the universe. Twenty-somethings (or even those in their later teens) are still young enough where they can truly take advantage of the power of compounding interest. Twenty-somethings are also a very self-gratifying generation. We know what we want and we get it, which isn’t always what is best for us in the long-term. I do believe that for some people “The Latte Factor” is a very viable alternative for finding ways to save money. If this saved money is investing wisely (which truly is not a terribly difficult thing to do) then it can (and will) lead to future wealth.

Overall I found this second chapter of The Automatic Millionaire very gratifying. It has some fantastic principles and sound advice for anyone to apply to their own lives. If you haven’t checked out this book yet I’d encourage you to get it, or at the very least check it out from your local library and give it a quick read (it’s very easy reading). David does a great job relating to anyone and giving sound advice, while keeping things entertaining.

A Financial Tool For Your Use

For those who are interested I threw together a spreadsheet which you can use to calculate how much money you could save over the course of forty years by cutting back on your expenses and saving a certain dollar amount a day. It’s a really easy spreadsheet to use, just plug in the dollar amount which you think you can save a day into the dark green box, which will then calculate the monthly savings and plug that number into everything else. The blue box will show the amount that you will have accumulated after forty years. Give it a try, you can download it by clicking HERE.

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November 30, 2007
Happy Holidays

I have been quite busy this past week between Thanksgiving and preparing for finals week at school. I will be coming back tomorrow with another Friday Book Club and I’ll be back full force next week, but in the meantime I wanted to link you to some of my favorite finance posts that I’ve written here at Debit versus Credit. Check them out and please leave me comments, I love to hear from my readers!

Loans and Credit

How Your Credit Score Defines You

Credit Cards 101

Budgeting

Starting on the Road to Wealth

My 33% Savings Plan

Investing

Investing 101

Retirement Planning

Are You Ignoring Free Money?

Thanks for reading. If you have any comments or suggestions feel free to e-mail me or fill out the contact form. I respond to all e-mails, so don’t be shy! Have a great weekend and look for an update to the Friday Book Club tomorrow!

November 29, 2007
Oh, America…

You’ve all heard the phrase, “keeping up with the Joneses.” If you haven’t, it means to covet whatever latest gadget, toy or whatever it is that your neighbor, friend, associate, or family member recently purchased. Of course we all pretend to not be so shallow as to live by this “rule,” but in actuality I’m willing to bet that at one point in your life you have made a “they have it, I need it” purchase. I’ll be the first to admit that I’ve made purchases this way. I’m not proud of it, but there’s no way that I can deny it. Of course making purchases on such a misguided impulse is NOT the way to financial independence, freedom or whatever it is that you may call it.

Wealth is not built outwardly

I can’t speak for other nations since I’ve lived in the U.S. of A. my entire life, but a disturbing trend which I’ve observed here in this country is the need to publicly display one’s “wealth.” You know exactly what I’m talking about, and maybe you’re guilty of it yourself: fancy cars, ginormous houses, fancy electronics. Don’t get me wrong, I don’t have a problem with nice things or fun toys. I do have a problem however with what’s seemingly behind all of these luxuries in this country, namely nothing… or worse, debt. It all comes back to the Jones, and trying to keep up with them. Please don’t fall for this trap. Wealth is not something that can or should be built outwardly. You’ll never become rich if you play this game. I know that driving a Mercedes would be awesome and attract people’s attention, but is it really necessary? Probably not.

Let me break this down into some numbers for all of you. You’ll see what I mean by saying that wealth is not something that can be built outwardly. I’ll be comparing the Smith family with the Jones family, both of which are completely fictional.

The Smith Family: Financial Analysis

The Smith family is not your typical American family. The family consists of Mr. Smith, Mrs. Smith and their two daughters, Chloe and Bree. They live in a modest single-family home, which they purchased 5 years ago for $153,000 dollars. Mr. and Mrs. Smith both work for a local insurance company and their annual household income comes to about $65,000 before taxes. They have two cars (a Toyota and a Mazda), both purchased used but still in fantastic condition. The Toyota is paid for and they owe $6,000 on the Mazda. They do not have any credit card debt, as they pay off any balances owed monthly. They currently owe $144,000 on their home.

Mr. and Mrs. Smith have both worked for their current employer for 11 years. They met in training, as they both started on the same day. They each started to contribute to their 401(k) immediately upon being hired. Their employer matches 100% of the first 5% of their contributions. Mr. and Mrs. Smith both took advantage of this matching and have each contributed 5% of their income to their 401(k), with their employers matching making an even 10% contribution. Their 401(k)’s are now worth a total of approximately $43,000. Their home is worth $165,000 dollars. The Toyota is worth $7,000 and the Mazda is worth $11,000.

Let’s do some quick simple math…

The Smith family assets total $226,000 dollars. Their liabilities total $150,000 dollars. This would give the Smith family a net worth of approximately $76,000 dollars. Not bad. They are in their early thirties after all, with plenty of years until retirement. At the rate they are moving now they’ll have a net worth in excess of $1,000,000 dollars by the time they reach the age of 65. Most of this worth would be from their retirement accounts. Let’s take a look at the Jones family now.

The Jones Family: Financial Analysis

The Jones family consists of Mr. and Mrs. Jones. They don’t have any children, but do plan on adopting a little boy in a few years. Mr. Jones works for a large snack-food product corporation while Mrs. Jones works on her own as a beauty consultant. Mr. Jones brings in approximately $80,000 a year while Mrs. Jones makes about $35,000 a year. Together their annual income equals $115,000 dollars. They live in a large single-family home with plenty of upgrades, which they purchased 5 years ago in a much desired neighborhood for $410,000 dollars. Mr. Jones drives a new BMW which he owes $32,000 dollars on and Mrs. Jones drives a new Honda which she owes $15,000 dollars on. They also live a luxurious lifestyle, which leads to an average balance on their credit cards of roughly $7,500 dollars. They currently owe $401,000 dollars on their mortgage.

Mr. and Mrs. Jones have approximately $11,000 dollars saved in a 401(k) plan. They only recently (2 years ago) began contributing to this plan… and contribute just 2% each, with their employers matching in full their contributions. The BMW that Mr. Jones drives is worth $35,000 dollars while Mrs. Jones Honda is worth $20,000 dollars. Their home is worth $440,000 dollars.

Let’s do some quick simple math…

The Jones family assets total $506,000 dollars. Their liabilities total $455,500 dollars. This gives the Jones family a current net worth of $50,500 dollars. Not very much, considering how wealthy they appear to be, is it? Let us also consider that by the time they turn sixty five if they continue with their 2% contributions to a 401(k) their net worth will be just under $1,000,000 dollars. About half of their wealth would be from retirement accounts, and the other half would be from their home (assuming of course that it is paid for at this point).

Oh, America…

I love nice things as much as the next person, but when we let our money control us, instead of controlling our money… something has gone terribly wrong. Please don’t let yourself fall for the idea that having nice things makes you rich. Just look at the comparison I made between the Jones and the Smiths… the Smith’s have a greater net worth, even though they appear to be “just getting by” at best, while the Jones family appears to be wealthy, but in actuality has almost nothing to their names (net worth wise). If you are rich (or save appropriately) please do enjoy the wealth that you enjoy… but before you do anything you should be saving a portion of your money to allow for your financial independence. Don’t let the “Jones” family run your life and influence the way you spend your money.

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November 20, 2007