Handling Finances

When I started this blog, my net worth was right around zero, I’d paid off my student loans and had just landed a great new job.  Even with a trip to London, a new digital camera, and the occasional car repairs, our net worth is climbing between $2,000 and $5,000 a month.  While I’m confident this is sustainable, it’s not really how we plan to live long-term.  My wife would very much like to quit her nanny job and volunteer more.  We’re also looking at buying a house and then making, buying and renting children (through pregnancy, adoption and foster care) so we’ll be paying interest instead of earning interest and our costs will increase.  At the same time, if we can continue to save just over $2,000 per month (including part of our house payments that goes toward principal) and don’t turn rabidly materialistic in the next couple of years, I think we’re in good shape to hit this goal.

My net worth is computed very simply.  I add together my retirement accounts and my savings accounts and subtract my credit card debt (which is paid off each month).  In Quicken this is automatic so the only thing I have to do is review the transactions to make sure everything is copacetic.  I purposefully don’t add in the value of our two cars as they’re both worth no more than a couple thousand dollars and we intend to drive them until they’re more trouble than they’re worth.  If I purchase a new car someday I might include it in my net worth, but even then I suspect I’d prefer to treat it as spent money rather than an asset I can buy or sell.  When I purchase a house, that will certainly be included in my net worth.

Quicken doesn’t track all my money as the $500 I’ve put into Prosper isn’t included and my wife has an account she uses for selling Avon that I choose not to track, but overall it gives a good picture of my financial situation.

It’s hard for me to think about reasonable and useful goals more than a few years in advance so I just figured I’d set my first longer-term goal at the arbitrarily significant figure of $100,000.  A little math showed me that I’d hit it by or at least in 2010 if our cash flow stays reasonably static so that’s what I’ll shoot for.  If history is any guide, that’ll be somewhere around half in retirement savings so I’ll have a good start on avoiding dog food when I’m too feeble to play with lasers.

Now that people are starting to get their tax rebates, our economy is in for some serious stimulation!  The idea is that we’re supposed to go out and buy new stuff which will keep businesses rolling along which will keep people employed.  Some might argue that we need a recession to drive inefficient companies out of business (freeing up workers and resources for better-run companies) but it’s a rather unpopular idea — especially now that our retirement savings are almost universally invested in the stock markets after years of our government giving tax breaks for 401(k) contributions.

If we step back for a moment and consider that the economy won’t totally collapse if every penny of the 100 billion is turned into profits and wages (it won’t), it will become clear that paying off debt will actually do as much or more to stimulate the economy than simply spending on consumer products.

Increasing future spending.

First of all, with every penny you pay back on your debt, you free up the monthly interest to be spent on other things.  Putting the $600 individual rebate toward debt could save as much as $150 a year in interest at an all-to-common 25% interest rate!  Today’s politicians are no-doubt counting on the stimulus today so they can take credit for the booming economy, but if we’re willing to think just a couple years out, the sustained effect of $100 billion less debt would be huge (and wouldn’t largely be wasted in profits to foreign countries).

Free up financial markets.

One of the biggest reasons for the current recessionary scare is sub-prime lending.  Sub-prime lending is hugely profitable as long as the economy is booming because lenders can charge exorbitant interest rates that more than cover defaults.  Of course, the banks book their profit each year and don’t generally set aside some of that profit to cover future defaults if the economy goes bad (or it wouldn’t be profit) so they’re stuck with huge numbers of bad loans that are no longer profitable as people become unable to repay them.

Banks don’t really want you to pay back your loan faster since they don’t earn as much interest that way, but in this case, the financial markets are so gummed up that every dollar they get back will be one more dollar they can lend out — further greasing the skids of our economy and getting everything moving again.

Ultimately, do what’s best for you!

Nobody’s trying to tell you what to do with your money, but I hate to hear people say that you should spend it or save it.  Politicians will benefit more if you spend it ASAP and make them look like they lead the economy well.  Companies worldwide will benefit more if you spend it on consumer products and a small fraction of it will go towards jobs.  The economy will benefit if loans are repaid (especially sub-prime loans) and banks will benefit if you continue to make minimum payments no matter what else you do.

In the end, look for where the money will do the most good in your personal financial situation.  While there are no strings attached, with the government running a huge yearly deficit (it doesn’t look so bad until you add in the regular “emergency was spending” to the budget), we’ll get stuck with the tab in the form of increased taxes or decreased services (say a 50% cut in social security payments?) in the long run.  While I’m a big fan of doing what’s best for my country and the world, ultimately, what keeps you self-sufficient will benefit those around you the most in the long-run.

I’ve written previously about my goals for 2008, but in reality I have many more goals than simply saving for retirement, buying a house, and traveling to England. In the past, I would simply use a spreadsheet to allocate the money in my savings account to different goals, but I found that rather tedious and would frequently just work on one goal at a time and ignore the rest. Having grown up with the internet and computers at my fingertips I’ve come to expect things to be automated and about a month ago, I found a great way to automate my goal-oriented saving.

Once you’ve entered all your information and started an account at ING, it’s extremely simple to create additional separate accounts for various purposes. You just pick which type of account (checking or savings — I only use savings) and give the account a name. I’ve started four accounts besides my main account for some basic discretionary spending in my life: Photography, Vacation, Auto and Charitable Giving. I also set up automatic transfers to each right after my monthly paycheck is deposited — I always keep enough to cover these automatic deposits in my main checking account so I’m not in danger of emptying my account and incurring fees.

Why save for smaller goals?

There’s another way to do this — I could pull money from my checking account when I want to give to charity or buy a new camera lens, and I could use my emergency fund for car problems. But car problems are predictable — you don’t know when they’ll come up, but you know that you’ll encounter them eventually! Putting money aside every month reduces and even eliminates the financial stress of car problems, and can spread out the cost of a new car into a high-interest savings account.

Aside from the auto savings, all my accounts are totally discretionary. These accounts serve two purposes: they limit my spending on photography and vacations, and they ensure that I will have money to spend in these areas when I want it.  Also, while my wife balks (with good reason!) at spending hundreds of dollars on camera equipment, saving for months to get a new lens both helps me to avoid impulsive purchases and calms her reaction to the cost of lenses “we don’t need.”  Avoiding marital strife and impulsive expenses all at once is a huge bonus in my book!

Saving for Goals Sets Priorities

Not only does this system reduce marital strife, eliminate impulsive purchases and avoid debt, but it makes your priorities obvious every month.  With automatic or manual monthly transfers to the savings accounts, you can assign priorities based on how much money you put into each account.  If I’m saving up for an overseas vacation, I might increase my vacation savings.  At the same time, I can either reduce my contribution to another account or simply live with less spending money for the month.  if I get some extra money (like the coming stimulus check) I can put part of that toward whatever goal I want as well as throwing some into long-term savings.  By increasing my photography account, I’ll be stimulating the economy… just perhaps not until I can afford that $7000 Canon 600mm F4L lens I’ve been drooling over!  (note to the wife: just kidding!)

Smartypig — the online version of my savings plan.

Smartypig.com has a really similar way to save for small goals. If you want to save up for your next vacation or a new car, you can put your money in an account with regular deposits. The site will tell you if you’re on track — factoring in your automated deposits and the interest rate. Unfortunately, although the site has a slightly higher interest rate than ING and other high-interest savings accounts, it charges hefty fees for everything from having gifts deposited by relatives (5%!) to getting back your money by check. Of course they don’t let you direct-deposit your money back into the account it came from because they want the 2% interchange fees they get from the debit card they want you to use. Overall it’s a bit of a racket and I strongly suggest perusing The Finance Buff’s review of the site at Free Money Finance before giving them a dime!

Whether you go with ING accounts, Smartypig, or just keep track of your categories on a spreadsheet, consider prioritizing your money with goal-oriented savings.  It’ll help your finances, teach you patience, and earn interest while you wait!