Saturday, November 14, 2015

Debt: Make a Plan

Nearly everyone starts out with few resources when they first become enter adulthood. Most people don’t have enough money to go to college for four years, buy transportation, purchase a house, etc. Even if you go a non-traditional route or if your college is paid by the state, it is likely at some point in your life you willpay back with interest.

For example, a credit card might provide you with up to 1000 dollars in which to purchase things without having to use your own money. However, this credit must be paid back, often if you do so in a short enough time frame you do not need to pay any interest. The trouble is, credit card companies, like all banks, are designed around making money. So they choose to charge an interest rate and often fees for various services. Sometimes these are equitable, small fees. In my case, the last time I was used my credit card abroad, I was charged a small fee for the service of currency conversion. This seemed very reasonable. Other fees are designed around making the credit card companies money, such as late fees. The last time I looked, my credit card’s late fees were something like 35 dollars. These fees strongly encourage you to be careful with your finances and to keep close track of them.

Today I want to talk about how debt can affect your in the long and short term and what you should do about it. In many of the financial blogs I have read they describe some arbitrary numbers that look like this:

Debt: $20,000 (@ 6% Interest)
Income: $100,000
Mortgage: $300,000 (@ 4% Interest, 30 years, fixed)

From here they would talk about if you should put your money into investments, the mortgage, savings or pay off debt. They might then talk about an investment that would make 10% interest and discuss the pros and cons in investing. In my opinion, this sort of example is too simple.  It doesn't even say if the income is gross (income before expenses, like taxes) or net (income after expense)!  Instead, let’s talk about debt. Debt is not free money but rather someone else’s money you are borrowing for a fee, backed by a contract. The debt in the scenario above shows:

  1. That is nearly 40% of the gross income for a year is dedicated to debt.
    1. 20% of the income would be required to pay off the debt, to say nothing of the sizable mortgage. The scenario does not say if the debt will increase in interest, as most credit cards charge more in interest than that. Perhaps it’s student debt, but that is still a sizable sum.
    2. 17.2% of the income is going to the mortgage. 
  2. The person appears not to have any savings.
    1. Maybe they have a 401K plan not shown, but they certainly don’t seem to have a safety net.
Often even these sorts of analysis do not consider the emotional factors around debt nor do they take into consideration the risk of losing your job. Even if this is two peoples' incomes, it is not likely they both earn exactly $50,000.  More likely, one person makes the larger share of income, and if that person loses their job, both people are will be in trouble. Really, what we have here is a large pile of debt with a debate over investment strategies. I submit a more important debate is if you should pay the debt off or prepare a ‘6 month plan’.

A 6 month plan is a plan that will allow you live at your current lifestyle for 6 months. Why that? First of all, it is easy to calculate, since all you need to do is look back at the last few months of expenses. If you don’t know how to do that, I suggest using financial management software such as Money Pig to assist you in the problem. Another reason is because 6 months may not be long enough, but you can always cut expenses, but once you have lost your job, you can’t increase your income. Now if you have a emergency, you can use the money saved up without the need for even more debt.

The alternate approach is to pay off your debt. This approach in the short term will save you more money, as you will not be paying interest on your debt. If you pay off that debt load and had an emergency, you could perhaps get more loans. This is a risk however, as some lenders will not be interested in you when you lack a job. However, this approach has two more big downfalls. The first is that you are still not learning the habit of saving. This habit is valuable and worth cultivating. The second problem is it might take you a long time to complete and you will not have that safety net for the entire time.

A third approach. Why not try a combination of the two approaches? I suggest that a 20% of your income go into savings, from the 401K, if you have it, to the emergency fund to private investing, with a bare minimum of 10% going to the emergency fund. I then recommend another 10% go into the debt, which would pay the debt off in a matter of years. Once the emergency fund is paid up, then I would put that money into paying the debt off. Once you are debt free (except for a mortgage), then and only then should you be debating various investment options.

Keep in mind, every situation needs to be custom tailored as there are always more complexities than can be captured in a single post.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investing advice and/or professional financial advice. Always consult with a licensed financial professional.

Sunday, November 8, 2015

Personal Finances: Organizing your Financial Life

Personal finances are one of the more difficult things to manage in adult life.  As children, most of us may have had allowances, but we didn’t think in financial terms.  We had toys, not assets.  We saw what we had as just an allowance, spending money, not an income stream.  We put money in our piggie banks, we did not deposit funds.  We bought our toys on impulse, or if our parents did some teaching, we might have had to save up for a toy.  We did not have multiple debt obligations competing for our funds along with social obligations and yes, still, toys we want to buy, even as adults.  At best, perhaps we learned a little of this playing games like Monopoly or possibly discussing it with our relatives and close friends.  All of that is not the same as living it day to day with all of life’s other complexities going on.

My goal today is to describe how you can organize your finances so that they are trackable and traceable.  While I will talk about tools, all of this can be done by hand or using one of a multitude of tools to solve the problem.

There are multiple different ways to slice the problem, but let me give you a few suggestions:

  1. Updating the Plan:
    A plan is just a map for a possible future.  The future is often different from your plan.  You must keep an eye on changes and adapt to them.  Gas may go up in price and that 100 dollars of savings per month may no longer be feasible.  You might get a bonus which allows you to pay your car off early and now you have a car payment's worth of money you no longer have to dedicate to car payments.  No matter what happens, you need to keep your plan up to date. 
  2. Gather Data: This can be what you know off hand, but I suggest you try to gather records from the bank.  Even if all you do is write down the balance at the end of the month for several months in a row, that will at least show you a trend line.
  3. Create High Level Goals and a Plan: The goal portion of this is what you want to achieve.  Do you want to have enough money for retirement?  Do you want to pay off your home mortgage as fast as you can?  You make a plan to help you reach your goals in a sustainable way.  The plan can be a budget, saving to get your first car or this can be about retiring with a certain amount of money in the bank.  The plan needs to reflect the realities discovered in the data gathering phase.  That is to say it needs to be achievable and realistic.
    1. NOTE: If you have a significant other, it is important that you talk about your goals.   Even if you choose to keep your finances separate, talking about goals and plans will give each other a sense of how you are doing.
  4. Working Towards Achieving Your Plan: Put effort into making your plan work.  Use automation such as moving money from checking to savings.  I suggest you pay your savings account first, or else you will be tempted to withdrawal from it.  If it is a 401 K, have your employer take it out of your account for you automatically.  If it is paying off your mortgage early, then have your bank automatically send additional payments.  
    1. NOTE: In my personal experience, it is better to have your bank control the automatic payments than to have the mortgage company take the money out of your account.  Banks often are more interested in making their system's customer friendly and allowing you to modify the rules, while mortgage companies have less motivation to provide top tier service.  So I suggest you run all auto pays through your bank rather than your mortgage lender, if you are allowed to. 
In the past, when people exclusively wrote checks, they would often keep track of the balance of their account in a little page in the back of the checkbook.  This was call the checkbook register and this was a way of keeping your checkbook balanced.  In today's complex world, few people still keep with this tradition, but there is some evidence that keeping records by hand helps your memory which in turn may help you realize your goals.

A frequent tool to organizing personal finances is a budget.  I think budgets are useful tools, however, never mistake the map for the road.  Budgets provide you guidance on how your income and spending should appear in a given month, but they are just there to attempt to describe an average month.  So rather than treating a budget as something you must follow exactly, I suggest you use a budget to give you map of how you can achieve your plan.

Some people find budgets less useful and would rather look towards trend lines.  That is to say, they would rather take previous income/expenses and average them out and see what the world would look like if those held constant for a certain amount of time.  These trend lines give you a glimpse into the future. In this trend line, you can see that the person's income is going up.

A example Money Pig graph.  This trend is up and to the right, exactly what you want to see.
The line is a trend showing an estimate of what the account total might look like in half a year.

Of course they don't take into account the pay raise or job loss you may experience in the future, but they do give you a degree of confidence that if you don't experience a change in your lifestyle, what life in the near future will look like.

The last method is to play it by ear.  That is to say, some people find that having an occasional formal check is all that is needed.  For the rest of the time, they just  use some built in measures to keep track of their funds.  One method may have an automatic withdrawal to a different account to buy that new car.  Another method may have keep their balance at some 'even number', such as 1000 dollars and if it goes over 2000 dollars they might reassess their finances.  These sorts of methods can be useful, but be aware that they also leave you vulnerable to surprises.  You might forget that you have to get an expensive car repair or other unexpected expenses.  These sorts of methods, without periodic inspections of a check list, can fall prey to such events.

All of these methods have different pros and cons.  You must figure out what does and doesn't work in your life.  You might notice that I wrote these methods in order from the most formal to the least formal.  I suggest you start with the most formal methods and as you get more proficient, you can then slowly move towards the less formal methods.  If you have life changing events, I again suggest going back the formal methods since that will help you learn what a normal set of income and expenses look like.  No matter which method you like, Money Pig can help you get there.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investing advice and/or professional financial advice. Always consult with a licensed financial professional.

Saturday, October 31, 2015

Understanding Finances: A Personal Account

In my personal experience, I have found that finances are complicated. I was 18 and it started out really easy, I was making just above minimum wage and I was paying rent to my mom. Then I started college, bought a car, needed car insurance, and kept making more and more money. I started wondering if I should get health insurance, which my employer did not provide. I bought a house, got yet more insurance, had friends whom I went out with, and of course, let us not forget the various consumer goods I bought, like my Xbox and TV. I spent 6 years in college, going part time because I was afraid of debt after amassing several thousand dollars in debt in the first year. I didn’t want to create more debt, so I choose safety over a speedy education. I also happen to be a self-learner, so I worked on learning software development and software testing over the years.

Then with the financial crisis I saw an opportunity. Like the Chinese curse, may you live in interesting times, I bought my house during the middle of the Great Recession of 2008. Towards the end of the Great Recession, I saw a nice house in a better location for me and I jumped at the chance. I decided that I could manage it if I rented out my other home, and I had always wanted to start my own business. This felt like a good place to start learning about running my own business. However, the only way I could do it was if I could get all the tax advantages from the rental. By this point I was struggling to keep track of what was going on. Adding a rental on top of it was making things too messy. I started with trying to create a simple rental management application. The more I worked on it, the more I saw I could generalize it to be about all my finances. And thus Money Pig was born.

Money Pig is not like some traditional financial software packages. It’s primary purpose is not just to try to enforce changes in your behavior by yelling at you when you’ve not saved enough but rather to allow you to gather insights about your finances. In looking to manage my money, I wanted something that would allow me to categorize my data and let me see trends. Then, as I was categorizing it, I realized how dull it was to do so by hand, so I built tools in to do it for me. Next up, I wanted to track what was a write off (from my rental or from donations), so I added that in too. I realized I wanted to see what the future would look like based upon my past year and I added another report. The next thing you know, this thing was making it really easy for me to tell how I was doing. I started telling my friends about it. They suggested features and I added a few. Then I stopped working on it. I changed jobs, life happened and I was only building it for myself.

I was talking with my boss one day, and he asked if I was doing anything cool with Money Pig. I told him no, I had not worked on it for some years. He then suggested, “If it’s that useful, why not sell it?” I started thinking about it. I had been slowly sharpening my business skills. I realized that other people might want other features, so I started adding some additional important features. I made Money Pig more secure. I made it support importing of CSVs support most formats, not just my banks. I made it easier to use. I started writing documentation. In effect, I made it what it is today. It no longer is just my Money Pig. It’s a tool for others to use.  It's our Money Pig.

So how do you understand your finances? While I can’t speak about specific cases, let me give some general guidance. You obviously want your income to go up, so keep your eye on that, particularly if you do not have steady income. If you have never done so, I suggest you hand-enter your entries in for a while. In doing so, you will gain insight into your finances. Just like in school, when you write things down, you recall them better. You can then start to see patterns and notice when something seems amiss. After that, importing financial data works just fine. You can then use the reports to notice things amiss rather than having to do everything by hand. When you do notice something odd, Money Pig allows you to write down notes about why some particular time was different than normal. You can also use a budget to keep track of your finances. These will help alert you to abnormalities in your finances. This will also help keep you from overspending or under saving.

I do want to pause here and make a few comments on my competitors. While I have found my methods work well for me, and I will continue to work to improve my software, I have no problem with you using my competitor’s software. I think it is better that you use what makes sense to you and make good choices than use a tool that does not make sense to you and make poor choices. Ultimately, I want you to succeed in your finances. Money Pig works for me, and in order to give you an opportunity to try it, I have a 30 day money back guarantee.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investing advice and/or professional financial advice. Always consult with a licensed financial professional.