October 31, 2008 – 5:55 am
Keep Your Financial House In Order
The current down turn in our economy has caused many people to refocus on their personal financial situations. The newspapers and evening news programs are full of tragic stories of foreclosures and repossessions. Trusted financial institutions are collapsing under the weight of bad loans and government officials are struggling to figure out a solution to our country’s economic woes. It seems as though there are as many solutions being proposed as there are economists and I wish I was well versed enough in macroeconomics to understand it all. Fortunately, I do not believe that I have to understand all of the nuances of the economy to properly manage my money. There is an old adage that says “all politics are local.” I believe that all economics are local and each of us can help solve our country’s economic crisis by working to keep our own economic house in order. Although, this sounds like a simple solution, the reality of the situation is that many people do not understand even the basics of financial management.
Know Thy Self
I do not claim to be personal finance professional but, over the past thirty years, I have managed to acquire all of the necessities of life and a few creature comforts while avoiding the staggering debt that has come back to bite many folks. I have listened to the advice of numerous financial gurus like Clark Howard and Dave Ramsey, some of which I agree with and some of which I do not. Make no mistake, I do not claim to be wiser than these folks. In fact, most of them have probably forgotten more about personal financial management than I will ever know. However, I know something that none of these personal finance authorities will ever know. It is the same thing that Socrates was talking about when he told the ancient Greeks that he was “the wisest man in all of Athens because he knew what he did not know.” In other words he was wise because he knew himself which is the first step in my personal financial management system.
Stop Digging
When you find yourself in a hole, the first thing you should do is stop digging. The same thing is true when you find yourself in a financial hole – you must stop doing whatever it was that got you there. The first step in this this process is to determine where “there” is. In other words, you need to sit down with a pencil and paper or your computer and make a list of your monthly income and expenses. You can put your computer to work to set up your budget with the help of Buddi. Buddi is a personal finance and budgeting program, aimed at those who have little or no financial background. It runs on both Windows and OS X and best of all, it is free.
If you are fortunate, your income exceeds your expenses and you have started building a nest egg so you can retire in the lap of luxury, send your kid to college or, if you drive an SUV, fill up your gas tank. If I were you, I would stop reading this article, pat myself on the back and go watch television. Actually, if you have a few minutes, you may pick up a pointer or two if you go ahead and finish reading the entire article.
However, if you are like most people, you will quickly come to the realization that you have a lot of money that has gone MIA (missing in action). In other words, your income exceeded your expenses but you have no idea where you spent the extra money that you know longer possess – not a problem, we will fix this later.
Finally, there are those unfortunate souls that did not stop digging soon enough. If you find yourself among those spendthrifts whose expenses exceed their incomes, it is time for some financial triage.
Regardless of your situation, by just sitting down and taking the time to determine your present location on your personal financial map, you have taken a major step toward getting your finances under control.
Building Your Financial Management System
I was grew up in rural western Pennsylvania, in a single wage earner family. That’s right, it was not until I left home that my mom started working outside the home. My parents worked hard all their lives but, other than our farm, they had little to show for all their sweat. My dad was a fulltime steel worker and a part-time farmer. He worked hard and he made a decent salary but things would always get a little tight a few days before payday. Looking back on it, the reason was quite simple. In addition to supporting six children, they were very poor money managers. They never saw the need to open a bank account since they rarely held on to their money long enough to need one. Every two weeks, my dad would get his paycheck, cash it, get a haircut and turn the cash over to my mom to pay the bills and buy groceries. My mom would pay for everything using cash and, as far as I can remember, the idea of saving for the future never occurred to them. If it did, they were probably more concerned about the present. It was not until later in life that my dad discovered the magic of compound interest and stock dividends. I have always thought that the lack of a financial management system was one of the primary reasons that my parents were never able to accumulate any wealth. There were just too many holes in their system for the surplus cash to fall through.
I have always believed that the best way to avoid frivolous expenditures is to avoid impulse buying. My problem has always been if I have cash in my pocket, I tend to spend it and apparently I am not unique. The solution is very simple, I cannot spend it if I do not have it in my pocket. So, my first recommendation is to open a checking and a savings account in a good bank that offers free checking and low minimum balance requirements. Your bank will serve two primary purposes. First, the savings account will be a staging area for your incoming revenues and the emergency fund we will discuss later. Second, the checking account will help you track your expenses. Make sure that the bank you chose offers free online banking and bill payment services.
After you have set up your new bank accounts, it is time to visit the Human Resources Department where you work to set up direct deposit. Direct deposit makes good sense for a variety of reason. First, your money is often deposited in your account sooner than if you are paid by check. Next, the money will be deposited in your account even if you are on vacation or sick on pay day. Finally, you will not be tempted to cash your check and skim off a little non-budgeted mad money if your check is automatically deposited.
There you have it – you have set up your financial management infrastructure so lets put it to work. Before long you will be rich beyond your wildest dreams – or not.
Putting The System To Work
If you followed my earlier advice, you should have already arranged to have your pay check deposited to your savings account and that is great. However, all of your household income should be staged in your savings account, including tax refunds, rebate checks and your spouses salary. I understand that some married couples have an arrangement where each spouse maintains control over his or her own income but I do not recommend using this type of arrangement. Good personal financial management takes commitment and discipline. I believe that a financial house divided cannot stand or at least it will exist on a weaker foundation. You can work around this issue but again, it will result in more holes in your financial system for your money to leak out.
Let’s begin by pulling out that list of income and expenses that you prepared earlier. Before you can put it to use, make sure that you have included all of your expenses. It is easy to forget annual expenses like personal property tax or car insurance that can sneak up and bite you if you have not budgeted for them. I use iCal, the calendar program on my MacBook, to send myself reminders about these large expenses at least a month out. Keep in mind, your goal is to accurately determine all of your monthly expenses so you have a big picture view of your financial situation.
Once you have determined how much money you need to meet your monthly obligations, each month you will transfer enough money from your savings account to your checking account to pay your expenses. This is where you can put that fancy computer to work for something other than playing video games, sending e-mail and surfing the Internet. I recommend that you pay all of your bills using your bank’s online bill payment service. If you add up the cost of the checks, envelopes and stamps necessary to pay your bills the conventional way, you will quickly realize that online bill payment is not only convenient, it is also a big money saver. Ask the customer service representative at your bank to walk you through the set up process and you will be off and running.
Now we have reached a decision point that will be unique to your financial situation. In addition to your normal monthly obligations, you will also have to decide how much extra money you will need to transfer to or maintain in your checking account to cover incidental unanticipated expenses. When I first instituted my financial system, I was happy to have $100 over the minimum balance that was required by my bank. The key here is to keep the amount of money in your checking account to a minimum since the interest rate is usually lower than the rate you receive from your savings account plus the money is more readily available for impulse purchases. Ideally, the balance in your checking account will continue to increase over a period of months as a result of spending less than you anticipated. When your checking account balance rises above the amount that you need for a given month, you get to make a “bonus deposit” to your savings account by transferring the surplus money using your online banking service.
Credit Cards Are Not The Devil’s Tools
When it comes to using credit cards, my attitude differs somewhat from that of most personal finance experts. My recommendation on credit cards is simple – use them but don’t abuse them.
This is where that “know thy self” thing comes into play – you have to know your weaknesses in this area. My weakness is cash! I can carry a pocket full of credit cards and never spend a dime but if you give me a few bucks in cash, it will vanish before the end of the day. For other people, a credit card is the enemy. They simply cannot suppress the urge to spend if they have a credit card that is not maxed out. There is also a third type of consumer that can walk around with a pocket full of cash and credit cards but still not spend a dime. We usually say they are so cheap that they get drunk before counting their money so they see double. However, these folks are unique – trust me I know, my wife is a member of this group. If you are in this third group, just skip this section. For the rest of you, it is decision time.
If you have come to the conclusion that you cannot use credit cards responsibly, go with the advice of the experts and cut up your cards – right now! How will you arrive at this conclusion? Its simple – if you are carrying a balance on one or more credit cards, you have already screwed up. In my humble opinion, credit card companies are nothing more than legal loan sharks. Remember what you should do if you find yourself in a hole? Well, the first thing you need to do is stop digging by getting rid of your credit cards then make it a priority to climb out of that whole by paying off your credit card balances. When you have a debt that is incurring an interest rate of 20+%, you have got to pay it off as soon as possible.
Of course, you may find yourself among the people like me who use credits card but do not abuse them. I have used credit cards for over thirty years and I have never once paid a penny of interest to a credit card company. My secret is simple – I use my credit cards as a financial management tool, not an unsecured loan. I use my card for convenience, not necessity, and I always pay it off in full when the bill arrives. Until a few years ago, we either withdrew cash or wrote checks for most of our normal expenses like groceries. However, the merchants make it a real pain to pay by check since they started to require multiple forms of identification, fingerprints, a polygraph and the rights to your first born male child before they would accept your personal check. My wife kept insisting that we should just use our credit card for all of our purchases but I resisted because I preferred the security of keeping track of our expenses in the check register. However, she eventually convinced me to give it a try and we have never looked back. I was afraid that our spending would increase without that constant reminder in the check register but I was pleasantly surprised to find out that our spending actually decreased. That’s right – we actually spent less money once we started using a credit card for all of our purchases. The reason is very simple. Before we started using the credit card, we would stop by the automated teller at the bank and withdraw enough cash to pay for our purchases before we went grocery shopping. Of course, we did not know exactly how much we would have to spend so we would withdraw some nice round number like $100. If our groceries ended up costing $80, the remaining $20 would tend to disappear down that black hole of other expenditures. Once we started using he credit card, the money stayed in the bank and, at the end of the month, we paid only the cost of the groceries. When you consider the fact that we go to the grocery store four times per month, that ends up being quite a windfall. In addition, my credit card company gives me a 1% cash rebate on all of my purchases. Now that we are using our card for all of our life expenses, that rebate has gotten quite sizable. Of course, I always use it to reduce my balance in the month it is issued. The bottom line is a credit card can be a great financial management tool if you “use” it instead of “abusing” it.
There is a third option, use a debit card issued by your bank to pay for your purchases. The bank debit card is sort of like a fake credit card since they can be used at any merchant that accepts Visa or Mastercard. However, they have some downsides that you should consider. First, any charges that you make are paid directly from your checking account. We found out from experience that, unlike a credit card where you are only on the hook for $50 if your card is stolen and used by a criminal, there is no such protection on a debit card unless the issuing bank provides the protection. Next, you always need to make sure you have sufficient funds in your account to cover your purchases before you make them or you will incur fees. Finally, some merchant put a “hold” on your funds when you make a purchase like gasoline. This “hold” may actually exceed the amount of your purchase and it may be in effect for several days thus tying up your money. Again, you need to assess the pro and cons of using a debit card. A good resource for information about debit cards is Clark Howard’s website.
In Case Of Emergency
If the recent economic downturn and bank failures have taught us anything, it is that we need to plan for a rainy day. All across the country, people are having their lives turned upside down as a result of layoffs and business closures. Even government employees are receiving pink slips as states attempt to balance their budgets during the tough times.
One of your first financial goals should be to build up an emergency reserve funds that is equivalent to three months of living expenses. If you are in debt now, that may seem like a monumental task but you will be surprised how quickly your savings account will grow once you set up budget and get your spending under control
In Part II of this series, We will help you triage your debts so you can figure out what to pay off first. We will also take a closer look how to improve your financial decision making skills.
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