Personal Money Management
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This book deals with finances, taxation, retirement funds, and other money matters.
[edit] Needs and wants
The idea of management implies that you have a goal or a set of goals in mind. Therefore, the first and most important part of money management is to clarify your own goals, commit to them and write them down. Why do you need money? What will you use your money for? How much do you need? For what? For When? Be specific and realistic. Different people have different needs and different wants. Prioritize your needs. Some wants and needs will have a higher priority than others. Make your priorities clear and allocate sufficient funds to each according to the importance you give it. Avoid inconsistencies. IE: If retirement is more important to you than owning a house, then more savings should be diverted to retirement than to housing. And, if funds are scarce, then you should fund your retirement savings before funding your housing savings.
Unfortunately, there will be times when you simply cannot fund all of your wants and needs. Having a priority list will help you decide where to allocate your limited resources.
Your priority list should be time-sensitive. For instance, college tuition may come before retirement in chronological order. So, you have to have completely funded the tuition before you have completely funded the retirement.
Here are some case situations and the amounts of money needed to fund them:
[edit] Case study
| Goals (Wants and needs) | Total required | Monthly savings required* | Time to target amount | |
|---|---|---|---|---|
| 1 | House | 200,000 US$ | 900 US$ | 19 years |
| 2 | Tuition | 160,000 US$ | 800 US$ | 17 years |
| 3 | Retirement | 168,000 US$ | 500 US$ | 28 years |
| 4 | Car | 120,000 US$ | 400 US$ | 25 years |
| 5 | Travel | 150,000 US$ | 200 US$ | 63 years |
| Total | 798,000 US$ | 2,800 US$ |
* You can calculate this by dividing the Total Required by the Time to Target (in months). ie: 200,000/(19*12)= 877 US$/month
In this case, every month in order to fully fund their wants and needs, they must save 2,800 US$. If the money is not there, they will have to sacrifice their wants and needs or delay them.
This scenario assumes a number of things.
The House cost is the amount of money you need to accumulate before actually buying a house in cash or getting a mortgage, in which case, the mortgage would become an expense rather than a savings item.
The Car costs include repairs, insurance, and a new 20,000 US$ car purchase every 7 years until age 60.
Retirement savings are in addition to government pension programs and will, hopefully, yield 400,000 US$ after 20 years. This is assuming that half of the money is placed in stocks at a 10% annual rate of return and that the other half is in CDs at a 3% rate.
A few things will skew the results of this exercise.
Firstly, the amount of savings required to reach your goal may be overstated because you may switch from renting to a mortgage faster than expected. This would seriously reduce the amount of money you need to save for your house. You will still need to repair it and to pay property taxes, but that shouldn't come to the total value of the house.
The time frame doesn't take into consideration compounding interest from your savings unless you figure it out separately as with the Retirement savings above. This can be a significant boost to your total savings.
Finally, and most importantly, the numbers here are AVERAGES over the entire career of the subject. That's why the numbers look so daunting. Most people get raises over time, which, in theory, increase the amount they can save. Therefore, the more distant goals can be safely underfunded for longer periods of time than the more immediate goals. If you have a 30,000 US$/year job and get 3% raises every year for 20 years, you would finish with 54,183 US$/year. Then, assuming you hit a plateau for the next 9 years, you would average 44,931 US$/year over the span of your career.
So, if you can't imagine ever saving 2,800 US$ per month, don't worry too much. The other factors mentioned above should lend a helping hand. However, those figures can be used as inspiration to let you achieve your goals faster.
We rarely hear of people who complain because they became rich too early in life and found they could safely retire much earlier than they had first planned.
End of Case Study
Writing down all of your goals in this manner will naturally lead to the next item in money management: The Budget.
[edit] The basic budget
Budgets don't have to be painful experiences. Now that you have a set of realistic goals for all of the money you will be getting and that you have an idea of how much money you will be spending, you can start to budget effectively.
For the first month, just count the ins and outs. You can use a normal notepad for this.
| August 2005 income | |
|---|---|
| Income (job) | 4,095 |
| August 2005 expenses | |
| Rent | 1000 |
| Insurances | 300 |
| Food | 200 |
| Entertainment | 100 |
| Clothes/Diapers | 100 |
| Phone | 98 |
| Train | 50 |
| Credit Card | 43 |
| Gasoline | 40 |
| Gas | 34 |
| Electricity | 20 |
| Mysteriously Vanishing Money | 165 |
| Total Expenses | 2,150 |
| Leftover cash from July | 820 |
| Leftover cash from August | 520 |
In August, they had 820 US$ in addition to 4,095 US$ from their income for a total of 4,915 US$.
They spent 2,150 US$ and had 520 US$ left at the end of the month. They therefore saved 2,245 US$ in August.
Counting the leftover cash in your wallet allows for a precise expenses count even if you forgot to actually count an item or two. The forgotten cash will show up as Mysteriously Vanishing Money (MVM).
Savings were distributed according to the priorities set out in Chapter 1 and were as follows:
| House | 700 |
| Tuition | 545 |
| Retirement | 500 |
| Car | 400 |
| Travel | 100 |
In case of unforeseeable emergencies when expenses exceed income, they use their travel money first, then the car money and then the retirement money to pull them out of the scrape. This is not recommendable. In fact, an extra savings account for emergencies should ideally be created and hold about 6 months worth of income to deal with the ups and downs of life.
Unfortunately, that is simply not possible for the family in the example above. They must therefore prioritize their needs and perhaps create a tighter budget.
[edit] Reducing expenses
Just the act of counting the ins and outs of your money will likely reign in some unnecessary expenses. Because everything is accounted for, showing your partner all of your Starbucks receipts may not be something you want to do... So, consumption may very well decrease significantly. Or, it may show up as MVM. If MVM goes up sharply, something may be amiss and a family chat in order.
[edit] Groceries
- Coupons
- Coupons are your friends. Clip them, collect them and use them. If possible, never buy a food item without coupons if it's not already on sale. Supermarkets often sell items at below-cost prices to attract customers. Buy those. Leave the high-margin stuff alone. Go to a number of stores to maximize the use of your coupons and notice how different stores make money on different items. Buy only the goods that are truly cheap.
- Eat vegan
- Eat foods like porridge grains and plant based foods. Meat, dairy and processed foods take more energy to digest and have the effect of making you hungrier, even though you've consumed more calories!
- Grow your food
- Try growing whatever comestibles will grow in your environment. Having a spice garden can be a cheap, low-maintenance way to save on spices. Compost and grow a fruit tree or a berry bush in your yard. This will make a big dent in your grocery bills and possibly attract more kids to play in the neighborhood which is a stress reducer.
- Eat healthy
- Learn to cook and eat fresh food and more raw food. Eating healthy is not expensive. The western and developed nations spend the most amount of money on food. Yet they are some of the most obese, malnourished and unhealthy people on the planet. If you're spending more than a couple of hundred dollars a month on groceries, there is something wrong with your eating habits. Volunteer at restaurants, learn about food and how it effects your nutrition. Understanding the role food plays in your life, might be the ultimate key to solving your money troubles and improving your health in the process as well.
- Shop locally
- Shop at your local grocers that you can reach by walking. Supermarkets usually have slightly lower prices, but the expense of driving forces you to buy large quantities which either interferes with your diet or wastes a lot of money on spoiled food. Smaller grocers have better quality because they can customize. The extra boost you get from carrying your groceries will keep you warm and healthier saving on heating and medical bills.
- Junk food
- Junk food is almost always overpriced. Try to cut down. Make your own junk-food such as 'smores or cakes and cookies.
[edit] Housekeeping
- Diapers
- Use cloth diapers if at all possible. They are much cheaper and better for the environment.
- Sales, special offers and freebies
- Free stuff can be okay but one should watch for the reason why something is free. Some trash is truely another man's treasure but not always. There is a carrying cost to having stuff so one should see how much utility to cost they would get from cheap stuff.
- Garage sales
- Some used goods can be really good. Baby clothes should all be bought used as they'll be useless in a few months anyway. Electronics get upgraded so quickly that only the richest can keep up. Buy used computers at reputable stores and keep them until they break. Then "upgrade" to the next model. Computers should not cost more than 150-200 US$/year.
- Internet and technology
- Use e-mail rather than the phone to keep in touch with relatives and friends... Especially overseas ones. Use tools like facebook and MSN to keep in touch with co-workers and associates reducing unnecessary meetings and trips for get togethers. Don't fool around with e-mail attachments and dirty sites that will infect your computer and require replacement. Get rid of your cell phone and only conduct your business online or face to face. This will increase professionalism and take out a lot of stress from your life.
- Conserve
- Energy prices are increasing. Walk more. Use your bicycle to cut fuel costs. Use a fan instead of the air conditioning. Put on sweaters instead of turning up the heating or do some stomach crunches to warm up. Always turn off the lights when you leave a room. Get a library card instead of watching television.
- Reuse and recycle
- Old clothes can become rags. Milk containers can become cutting boards. Misprinted material can become fax paper.
[edit] Other
- Entertainment
- Try out cheaper entertainment. Instead of going out to a restaurant, why not a picnic? It'll be much cheaper and healthier. Only go to the movies on cheap night, at the cheap theater. Try renting movies instead or use NetFlix' service to rent unlimited DVDs for a fixed monthly price. You may not even need to buy cable! Bicycle rides are cheaper than drives. Home parties are better than going to the bar with your friends. Get in a habit of going to your local parks and being nice to people there. Be friends with your neighbors. Overcome social stigmas and stereotypes if you have to and meet people locally instead of going to bars and clubs and getting hung over the next day.
- Spirituality
- Try to go to a place of worship closest to your home. Ultimately, you should be attending somewhere within walking distance. If you can not get along with the people at the church across the street because of their race or culture or other personal differences and have to drive or bum of rides to somewhere half way across town just to worship, you have probably missed out the whole point of going to church. Do the things you enjoy, even if it means being alone or not going to church until you are ready. This will save a lot of money on alcohol, cigarettes comfort food or medical expenses in the long run.
- Share
- Carpool to work. Once you're done with your children's clothes, keep them and give them to a family member. Take any old children's clothes that are in good shape and still semi-fashionable that your relatives and friends have to offer. The same goes for strollers and baby seats.
- Re-gift
- Got a gift you don't need? Give it to someone else instead of throwing it away. If you don't have a friend available, take it to the front or in a visible area where one of the neighbors can pick it up. You might just make more friends.
[edit] The revised budget
Now that you've thought about how to cut your expenses, it's time to get to it! Some expenses of course are fixed and so cannot be easily cut. In the example below, rental fees are exorbitant but reducing them would entail moving elsewhere... Not a realistic solution. So, what can be cut? Food, ET and the phone bill look like prime targets. Another important one to hit is MVM as it usually represents items which you can do without... after all, you don't remember buying them! Utilities and gasoline are already quite low, so don't need to be taken care of. Gradual cuts may be better than taking out 50% of one item in one fell stroke and suffering through the entire month, only to face the uncontrollable urge to splurge on that item next month. Perhaps cuts of 10% a month would be easier to bear.
| August 2005 income | Target budget | |
|---|---|---|
| Income (job) | 4,095 | 4,095 |
| August 2005 expenses | Target budget | |
| Rent | 1,000 | 1,000 |
| Insurances | 300 | 300 |
| Food | 200 | 180 |
| Entertainment | 100 | 90 |
| Clothes/Diapers | 100 | 85 |
| Phone | 98 | 88 |
| Train | 50 | 50 |
| Credit card | 43 | 43 |
| Gasoline | 40 | 40 |
| Gas | 34 | 34 |
| Electricity | 20 | 20 |
| Mysteriously vanishing money | 165 | 150 |
| Total expenses | 2,150 | 2,080 |
| Leftover cash from July | 820 | |
| Leftover cash from August | 520 | |
Hey, not bad! You have shaved 70$ from your budget. That's a great start. Continue doing this every month until you feel you are living *too* cheaply and yearn for a better life. Then, loosen up a little... just a little! Just enough to feel the difference between extreme poverty and the point where you enjoy life again. So, enjoy life, but on the cheap side!
[edit] Dealing with debt
OK, so now you are living cheaper and as a result have some extra money left-over from your immediate survival-based monthly expenses. Time to slay the Debt Monster... or is it?
One important decision to make is where to allocate the extra 50$ you made. Will it go to pay down debt or will it go to savings?
Money has momentum. This is why the rich get richer and the poor get poorer. Money's momentum is exponential as a result of compounding interest.
If you have 100$ of savings at a 10% interest rate, it will not take 10 years to grow to 200$. It will take 7.2 years.
Likewise, if you have 100$ of debt at a 10% interest rate, you will owe 200$ in 7.2 years if you don't repay your debts. Only repaying the interest will keep you in poverty forever.
We arrive at these numbers using the "72 Rule", which is simply to divide 72 by the percentage of interest you have to see how many years it will take to double your capital. So, debt at 12% will double in only 6 years. Credit card companies get rich by having you pay only the minimum on your card. A future chapter will deal exclusively with credit cards but let us just say that the minimum payments are designed to keep you indebted (and thus paying) forever.
So, money that has to go to repay debt is money that is not working towards making you richer. To decide whether to repay debt or invest, consider the rates on both propositions.
If you can invest your money safely (ie: NOT stocks, options, commodities, baseball cards or other 'risky' investments) at a higher interest rate than your debts, you might consider investing the money and using the spread between the money you make and the money you lose to pay your debts. (This is the idea behind margin, which we will get to in time.)
For example, if you can make 5% interest on 100$ using a safe investment which you understand but your 100$ debt rises at a rate of 12%, you are better paying your debts before worrying about investing. You will "save" 7$/year by paying your debts rather than investing.
If, as in the 1980's, you had interest on a 100$ 5 year CD at 12%, investing in that safe vehicle might have been better than paying down the 100$ debt owed to your mom and dad at 5%. In this case, your spread would be 7$/year. In this case, that's REAL money in your pocket which you can then put down on debt or again on investment.
In today's low rate, high stock PEs and potentially inflationary environment, finding a safe investment that will return more than the interest rates of your debt will be challenging to say the least. It may then be far better to simply pay down your debt and make sure that it doesn't come back anytime soon.
[edit] How do you pay down debt?
Firstly, you need to itemize your debt. Make a list of all of your debt and the rates on each type of debt. This should include credit cards, mortgages, student loans, money owed to your parents, car loans etc.
Here is an example (If someone has actual debts, feel free to replace my fictitious example with a real-life one.)
| Debt name | Debt amount | Interest rate |
|---|---|---|
| Mastercard | 100$ | 12% |
| Mortgage | 100$ | 3% |
| Car loan | 100$ | 7% |
| Student Loan | 100$ | 2% |
| Visa | 100$ | 16% |
| Mom and Dad | 100$ | 0% |
| DIC card | 100$ | 28% |
To put this into perspective, 700$ of total debt will generate 68$ of extra debt per year. Nearly a 10% average rate!
[edit] Not all debt is equal
Some of the debt in this example has little momentum and some has tremendous momentum! When you decide where to put your 50$, pay off the minimums on everything to keep up your credit score. After paying the minimums, put EVERYTHING on the highest rate debt, the DIC card at 28% in this case. Deal with it item by item, as you slowly get out of the debt pit.
[edit] Don't add to your debt!
Just as important as getting rid of the highest rate debt first, so is not adding more fuel to the fire at your feet. Stop using your cards! If you can't pay for it in cash, you cannot afford it (today). Wait until it's on sale or until you accumulate enough cash to pay for it, or better, both! Basically, if you have a mountain of debt, you got here by living above your means and as long as you continue to do so, the mountain of debt will not shrink and disappear. You will be a slave to your debt forever.
Again, kill the debt one bit at a time and don't let it grow back. Burn your cards if you have to.
[edit] Dealing with credit cards
You don't need them. Or at least, you don't need to keep a balance on them. Ever. Period. If your income is insufficient to let you live the lifestyle you wish, you need more income or a plainer lifestyle, or both. If you're a student, get loans or grants or mooch from your family before going to plastic. Credit cards give you access to instant "money" which you will have to repay at over 10% interest rates starting next month. Unless you are buying your food on plastic, you can wait a month for your new doodad. If you are buying food on plastic, you need serious help. Over the long-run, paying in cash at all times will save you thousands of dollars.
They always say that time is money, and if you can manage bank acounts and can pay your credit cards off on time, then you can profit from the fact that credit cards let you pay later. Start off by putting all your cash in a high-yield bank account. While you're spending money, the cash is accruing interest. When your payment is due, then withdraw the money from the high-yield account and you'll see that you have more money than you would have with having cash in your wallet. Despite the fact that this can be a good technique to make some extra nickels and dimes that add up over time, the psychological factor of having only a limited amount of cash in your wallet might prove to be more conducent to saving.
How many credit cards do you have? If you answered more than "one", then think, why is that? If it's because one card is for airline points, fine. Otherwise, wouldn't it simplify your life to cut down on the plastic? You may also note that different cards have different rates... consolidating debt is an effective way to reduce it. Bring all the debt you can onto the low-rate card. Destroy the debt on the high-rate cards ASAP. Lower your current rate by calling the credit card company and simply asking them for a lower rate. If you make your minimum payments on time, you may well have success.
For some, it may be possible to transfer your credit card debt into a second mortgage at better rates than the cards. (Providing that you own your house.) If you choose to do so, you should still try to pay that debt ASAP. Even at a lower interest rate, if you extend your debt over 30 years you will end up paying much more in interest in the long run. $10,000 compounded at 5% over 15 years is more than $10,000 at 15% compounded over 5 years. Use the lower interest rate as an opportunity to pay your debt faster, not as an opportunity to max your credit cards again.
Use credit cards only for their convenience factor when caring cash is troublesome. Use online banking to pay of all your bills right away and free up your mind to focus on other problems.
[edit] Savings vs investing and the nature of money
OK, now thanks to your budget reductions, you've eliminated your debt, or at least brought it down to levels where you can envision saving some money! Congratulations!
Savings are basically moneys put aside so that it can be used to buy something later. Investing, however is buying an asset in the hopes of making some money from it. These are two very different concepts! It's important to realize the difference. Savings are moneys not spent. Investing is spending.
That being said, your house is not a source of savings! Nor are your stocks, nor your bonds, nor your baseball cards.
Savings are money. OK, so what's money?
According to the U.S. Constitution, money shall only be silver and gold. So there you have it: Money is silver and gold. Nothing else.
Actually, paper money was also gold until the gold window was closed in 1971. Before that point, one U.S. Dollar represented a fixed amount of gold which had to be physically held in the U.S. Reserves. The famous Fort Knox. So, paper money was, in effect, gold.
After the window closed, money became a fiat currency. Ie: not gold or silver.
So, what's the difference?
While paper money was still gold, the government couldn't print it at will. They needed to first acquire gold before printing money. This is the process that gave paper money meaning. Now that the gold standard is removed, money "floats". Governments can print as much money as they want but because money is weighed against other currencies, if one government prints too much money and floods the market with its dollars, the value of that currency will drop. This in turn will raise prices. Inflation.
So, what does that mean?
Basically, it means that paper-money savings are not risk-free. The nominal value of your bank accounts may go up, but you may lose buying power over time. As an example, if you make 1$ from the interest on 100$ in your bank (yay!) but inflation goes up by 2% you did not gain any new purchasing power from the nominal 1$ gain in your account. You have in fact, LOST money.
To complicate things, there are also times when the opposite happens. Your purchasing power increases while the value of assets decreases. This is what happens in depressions and recessions. In Japan, for example, banks in 2005 have a 0.005% annual interest rate but the country has been in a recession for 20 years. So, every year, 10,000yen (100 dollars) will give you 50yen (50cents) but deflation is maybe 1%, so you GAIN 150yen of purchasing power.
[edit] Money windfalls
Money windfalls can be a good or bad experience - depending on how the windfall is managed. Often times, personal financial windfalls can cause strain on relationships for the parties involved. Therefore, it is important that the receipient communicate, plan, and execute his or her plan of action regarding the use of the windfall.
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[edit] Work
Try to combine your work with your hobbies, so that you're doing what you like and can avoid the extra step. For example, if you like sports, try to get a job in construction which allows you to be physically active and avoid the gym fees. Similarly if you like food and cooking, get a job at a restaurant even volunteer, instead of spending your own time and money to cook at home.
Try to work close to home or even from home, use internet and technology to help you achieve this. E-mail and instant message your associates instead of spending time and money on faxes, pamphlets and cell phone bills.
Try to work in the closest establishment to your house. A higher pay might be enticing to put up with the traffic and travel time, but it's not worth it after taxes and travel cost cutting into your private time. The reality is that much like people, all businesses are the same. If someone was willing to pay you for your skill at one business, likely you will be able to implement your talent just as well anywhere else. Remember, time is money.
Don't switch jobs often or take another job simply because it has a little better pay. These days employers are spending a lot of effort to solicit the work force. Almost always it turn out too good to be true. The rule of thumbs is that if you don't know how your boss makes all the money, don't take the job. You will be saving your self a lot of headaches which will turn out to save you money and your health in the long term. Take a job that allows you to move to downtown where everything is withing walking distance and sell your car.
[edit] Taxes
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[edit] Retirement
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Retirement planning is a multidimensional field. Many of us approach retirement planning from only an investment point of view. This perspective is too limited for dealing with the diversified needs that we may have from our retirement plan.
For an effective retirement planning, you should take into account following factors and decide the type of planning to be done:
- Employer provided retirement plans
- Social security measures available
- Taxation issues
- Insurance coverage
- Investments
- Health care requirements
- Changes in lifestyle
Setting aside of funds during the earning span of an individual and channeling the funds in a secure and remunerative manner with a view to achieving the present and future objectives is an important aspect of retirement planning as also in the case of a comprehensive financial planning. It makes sense to create a well balanced portfolio that suites your retirement planning objectives. Strategic Approach to Retirement Planning
The word strategy refers to planned efforts being implemented to reach the predetermined objective. Therefore, the activities are to be prioritized and directions are to be defined with reference to the goal set.
Strategic approach to retirement planning will include:
- Analysis of the available retirement benefits from various sources, such as the State, the employer, etc. to arrive at the additional needs to be met
- Dependency needs of self and other family members requiring continued income flow
- Anticipation of possible changes to the employment conditions and the family circumstances which may require transformation and the continued innovations in the field of medicine and microbiology. Require changes to the retirement plan
- Decision on the savings pattern out of the present income to build the required corpus for the visualized and prioritized needs
- Proper selection of investment strategies on the basis of defined yield and rate of accumulation
- Analysis of risk elements arising during the process
- Building flexibility for reshuffling of investment portfolio in case of a need arises.
[edit] Spreadsheets and worksheets
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[edit] Sample wants/needs lists, budgets and revised budgets.
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[edit] Authors
- Miguel Gervais, Owner of MLC Eikaiwa (Contributions)
- David Grizzell, Student of Finance
