The envelope budget
Budgeting can be very difficult. With one swipe of a credit card you can buy now and pay later for virtually anything. With this type of mindset it is hard to budget for expenses. The envelope method of budgeting makes keeping a budget a lot easier and will prevent you from spending beyond your means.
Start by figuring out how much you spend on each category of your budget. Food, utilities, clothing, luxuries etc. For each category you should then obtain an envelope and write the name of the category on the outside. At the beginning of each month, place the appropriate amount of CASH in the envelope.
You are to spend only the amount that you place in your envelope. This will help you visualize the amount of money you need through the month and how much you are actually spending. You will not realize how much the grocery costs you until you start paying with cash rather than a swipe of the card. Handing over a stack of $20 bills can be a bit demoralizing at first, but it is for the greater good.
The envelope system works because you only spend what you have. You cannot reach into the bottom of the envelope and find more money, nor can you borrow from other envelopes because chances are that they are running low as well. For people who cannot stick to their own written budget, it is a lot easier to follow through with the envelope budget. You will quickly forget about your savings accounts and how much you are actually saving by keeping money in itemized envelopes. When you have only $50 allocated to spend on eating dinner out, you will make it will make your decision, and quite possibly the overall enjoyment of that dinner, much more valuable to you. The key is to stick to the system and only use each envelope for its intended use.
You will find that the envelope system really helps you visualize your budget as dollar bills rather than payments that need to be made. Give it a try.
Why target date funds may not be good retirement plans
Filed under: Financial Advice and Advisers, Investing and Saving, Money Management |
Comments(0) Many retirement programs and pensions have limited their choices when it comes to funds. Many 401ks and other programs only offer a select few mutual funds called target funds. These funds seem great at first, until you look at the high fees and the generalities surrounding them.
Target funds are usually sold by dates every five years. A target fund is sold as a date such as “2045” and will be invested in a style that will best fit someone who wants to retire by 2045. The underlying problem is that some people need high growth rates to retire at 2045, while others just need to earn a decent return. Target funds should not be taken as a promise that you will have sufficient funds to retire in 2045, but rather that the manager will allocate assets as best as he or she can to grow your wealth now, and protect your capital as you near retirement age.
Often these funds are just a “salad” of other funds. The managers place money in different mutual funds to reach a generally accepted asset allocation to protect your money and provide decent returns. Unfortunately, this means you also pay double fees as you will have to pay for the manager to manage your money and for the fees for the funds in which your money is invested. The target fund is merely the middle man for other funds.
These funds also rarely ever have your best interest in mind. The manager will likely take the target fund money and invest it only in funds offered by the same firm. It would be equivalent to a stockbroker only selling you investments that he holds, or selling you the highest rate fund he can find. Target date funds have a large amount of capital because of the overwhelming number of investors who are privy to getting ripped off.
If you can, try to avoid the target date funds altogether. For the most part, they are nothing but renamed index funds with double the fees.
Why the FED rate cuts are not indicative of lower consumer rates
The federal reserve rate cuts might make you feel better about getting a loan, but for most people, the rate cuts do not dramatically impact consumer level loans.
Banks operate on a very thin margin between the Federal Reserve rate and the amount that borrowers pay to lend. If the banks are borrowing at 3%, the consumer will commonly receive a rate of 6% to 7% on a home loan. The difference is what the banks earn by borrowing low and lending high. Unfortunately, even when the Federal lending rates drop, banks are unlikely to continue lowering rates.
When you borrow from a bank with a fixed loan, you are practically getting money from a middle man. Although you may have borrowed at 7% on your home, the bank will often procure a loan from the Federal Reserve at 4%. The banks loan is locked in at 4%, just as yours is fixed to 7%. If rates were to skyrocket, you would get the same rate and the bank would still have a line of credit from the Fed at an equally lower rate.
Banks accept a high level of risk for their lending practices, which happens to be the primary why the rates are not dropping. If the bank is unable to collect money from the borrowers, it still has to make payments to the Federal Reserve for their loan. The banks like to have a comfortable margin to accept the risks of people going under. In effect, loans operate just like a insurance policy. The extra 3-4% over the Fed rate allows the bank to lend money while still staying profitable.
Just as gas prices are quickly to go up when wholesale prices go up, and slow to drop when the wholesale rate drops, banks operate in the same fashion. The extra that you pay protects them when people can no longer make payments. It is unfortunate, but the rate drops are more likely to help banks than they are to help consumers. At extremely low rates, banks would rather invest the money themselves in other things than give $100,000 to the average homeowner for a new home.
Will the next president hurt your bank account?
In short, yes. All three presidential hopefuls want to lower taxes and limit tax hikes. However, all of them have vast social programs that will eventually cost billions in taxpayer dollars. Here is a quick run through of Hillary Clinton, Barack Obama, and John McCain with a quick glimpse of their policies.
Hillary Clinton
- Seeks immediate relief for housing crisis
- calling to freeze interest rates
- Co-sponsored bills totaling $502B in spending thru 2005
- Voted NO on paying down federal debt by rating programs’ effectiveness.
- Voted NO on $40B in reduced federal overall spending.
- Higher Social security tax
Barack Obama
- Bush stimulus plan leaves out seniors & unemployed.
- Help the homeowners actually living in their homes
- Save $150 billion in tax cuts for people who don’t need them.
- Rejects free market vision of government.
- Voted NO on paying down federal debt by rating programs’ effectiveness.
- Voted NO on $40B in reduced federal overall spending.
- Higher Social Security tax
John McCain
- Continue strong in Iraq
- Voted YES on $40B in reduced federal overall spending.
- Private social security accounts
A quick glimpse at the candidates platforms show that many of them would continue with the same federal budget, and all of them have shown a net increase in the budget. Their stances on each federal program, and program types are different, but total spending is the same.
The biggest cost to taxpayers, and an integral part to the 2008 election, is the war in Iraq. Two candidates, Hillary Clinton and Barack Obama both want to put a timetable for withdrawal in place - although Obama’s would be much sooner than Clintons.
John McCain wants to continue with the current strategy in the war on terror, and is adamant about staying in Iraq for as long as it takes, even if it takes 100 years. Ending the war in Iraq would save US Taxpayers roughly $150 Billion per year and cut the Federal Deficit by nearly half. The war is a much bigger expenditure than most people think.
All three candidates want to aid in the subprime blowup, which will cost even more in Federal money. After the buyout of Bear Sterns, all candidates agreed that the citizens of the United States needed assistance in keeping their own homes. No bill has yet to pass regarding new funds for homeowners, but it should remain a key talking point in Congress.
Hillary Clinton and Barack Obama support raising the bar on Social Security taxes so the upper class pays the current tax rate on more of their income. John McCain does not support the measure; only wanting to privatize social security so each person can make their own decisions.
As it appears, every candidate will affect your bank account negatively. Hillary Clinton desires more homeowner assistance and greater social programs, while requesting higher tax ceilings on social security. Her call to end the war in Iraq will lower the federal deficit, but not until 2012, her date of withdrawal.
Barack Obama wants to end the war in Iraq as soon as possible, but wants higher social security ceilings and more social programs than the two other candidates. It is safe to say that the savings from the war in Iraq would quickly be spent in more social programs. Universal healthcare being the key expenditure.
John McCain is also likely to increase the federal budget. Although he highlights his ability of foresight for the bridge to nowhere (which would serve 200,000 people) and various military expenses, he is willing to continue with the $150 Billion a year war. He supports some kind of health care aid much like his two democratic challengers although not as widespread.
Gold prices indicate economic instability
The price of gold is something that is highly debated by economists from varying schools of thought. The Austrian school of thought says that the value of gold is inherent and never changes, but that the value of fiat currency changes, and thus the price of gold. Other schools of economic thought argue that gold prices can go through boom bust periods, just like any other commodities. In history, the Austrian school of economics seems to win out.
The price of gold has been going up rapidly. Just a few years ago in 2003, the value of an ounce of gold was right around $270 per ounce. Fast forward to 2008 and the price of gold has quickly risen to $1000 per ounce, now down to the low $900s. This flee from fiat currency to gold has some investors worried that the world’s markets are about to enter a meltdown.
In the history of fiat currency, not a single one has lasted the test of time. Romans introduced the fiat currency, but after a series of wars and other large expenses, a loss of appetite for a fiat currency eventually fell to inflation. The problem with a fiat currency, Austrian economists argue, is that currency can be rapidly devalued due to inflation. The Romans did that, over history they clipped coins and printed currency that was not backed by anything of value. Because of this, historians warn, the world’s great empire faltered.
Now that gold prices are reaching their peaks there comes a new worry that inflation is rapidly devaluing the worlds currencies. The dollar has been devalued by over 97% in spending power since 1913, the year the Federal Reserve was created. Due to a larger money supply the market corrects itself with higher prices for goods.
The US Dollar has gone through some very important moments in history. In 1944 as WWII came to an end, the US Dollar was said to be as good as gold, thus the world placed their reserves in dollars rather than metals. By 1971, Nixon knew that the amount of gold would never cover the amount of dollars in circulation, thus the US went full-fledged fiat currency, no longer backed by any amount of gold.
The value of gold seems to be in a boom period for just the last 5 years after more than tripling in value. The expansion of credit during the 1990s and 2000s with the real estate boom boosted money supply and drove down the value of the dollar. Now that the dollar is no longer pegged to a specific value of metals, the price of gold floats with the amount of money in circulation.
Just in the last 6 months, the value of gold has risen from $600 per ounce to $1000. This gives us early warning signs that the amount of credit in the system is far too high and people are afraid to hold onto dollars. The money supply grew similarly today to how it did during the last Great Depression by doubling from 1920-1929 then dropping greatly from 1929-1933. Could it happen again? Austrian economists say yes.
A look at how your credit score works
Credit scores determine everything from job positions, insurance premiums and most importantly, the interest rate assessed to your line of credit. Your credit score is your worth as a borrower and a way for banks to determine risk. A high credit score shows that you have paid your bills on time, and that you are in good standings with your current creditors. A low score shows that you are unlikely to repay your debts. A credit score is calculated several factors, race or gender do not play any role. Neither do things such as time length of employment or medical history.
Your credit score is calculated by the amount of debt you have, the types of debt, how often you have paid your bills timely, how much new credit you have been seeking and how long you have had credit.
The largest portion, 35% of your score, is based solely on your payment history. If you have paid on time without being late on payments, chances are good that you will possess a good credit score. Lenders like to see that you can pay them back in a timely manner, thus they give lower rates to people with good credit.
The next 30% is based on how much money you owe, also known as utilization, or the amount you have used of each line of credit. If you have spent $10,000 on a credit card with a $15,000 credit line, you are above a 50% utilization, therefore your score will be negatively affected. Creditors like to see that you can manage your credit lines, rather than be slave to them.
Another 15% of your score is dedicated to your credit lifespan, or how long you have had credit lines open. Keeping old credit cards open, even if you do not use them, helps boost this part of your score by raising the average age of your accounts.
The remaining 20% is split between the types of credit you have open and how much credit you’ve been seeking. Its good to have a portfolio of credit, such as a credit card, mortgage and a car loan. This shows that you have experience with debt. The bank also takes into consideration how many inquiries are on your credit report, if you are actively seeking credit, you probably are in a financial hardship. When this is the case, most often lenders will either not want to lend you money, or they will do so at a greatly increased interest rate.
Let credit cards pay you
Frequent flier miles, cash back on gas and fast food purchases and a free 55 day loan? Many people associate the savings of cash back and miles as the only way to produce revenue from a credit card. In fact, a credit card is a great way to buy everything on an interest free 55 day loan while collecting the card’s rewards.
Credit cards and their billing cycles can be very difficult to understand. Generally speaking, a billing cycle is a 30 day period on which you can make charges followed by a 25 day grace period, or the amount of time before a credit card payment is due.
Take for example a large purchase such as a sofa. You want a great new $700 couch to put in your living room and of course want to pay as little as possible for it. If you were to charge the couch on the 5th of the month, you would only be 5 days into your billing cycle, therefore you still have 50 days to pay it off; 25 more days in the billing cycle and 25 day grace period.
Instead of paying cash, you put the couch in a credit card for $700. You will not actually have to pay for the couch until the bill is due and you will profit from any rewards programs (such as 1% cash back) in the meantime. Just by using your credit card, you will get a nice $7 back in rewards, and receive an interest free loan for 55 days, or 50 days in this example.
Another benefit is that your cash can sit in your bank account until the payment is due. Considering a 3% yield on deposits, you will earn an additional $3 just by keeping the amount ($700) in your bank account. In total you are receiving a return of $10 for the $700 purchase that you were planning to make anyway. You can see over the course of a year how quickly your savings will add up. A credit card can be used to pay virtually everything, mortgage, utilities, gas, groceries all on a 55 day interest free loan.
If you were to use a credit card for your entire monthly budget of say $2500, you would get $25 in cash back rewards and save $11 in interest each and every billing cycle. A $36 savings just by paying with a different medium is nothing to balk at, that is like getting your cable for free.
Online banking versus brick and mortar
Online banking is something that no one could have predicted. Now you are able to access your accounts at any time, make payments and see your statements from home without going to the local banking branch. Online-only banks have also sprung up with no actual branches, just a virtual account that promises higher savings rates and a slew of conveniences. For the average person, it would be perfectly acceptable to have both an online banking account and a brick and mortar bank.
Online banks generally have the best rates as they strive to cut costs by hiring a limited amount of workers (no tellers needed) and avoiding the costs of buildings, atms etc. The downside is a limited access to money and the inability to go to the bank and talk to a person if you need to. Most online banks will allow you to pay bills online, however, they do not offer easy withdrawals like the thousands of offline brick and mortar banks.
Brick and mortar banks are best for people who demand customer service. From the availability of many banking options, fee-free ATMs open 24/7 and the candy at the corner of the banking desk; brick and mortars have it all. They also have many costs that cut into savings rates, and make their lines of credit and loans more expensive. Brick and mortars offer a high level of comfort to customers, ensuring them that their money is right around the corner when they need it, rather than just a digital number on a computer screen.
For long term savings, an online bank is the winner hands down. Savings rates at online banks are much higher and the fees are much lower. An online bank is perfect for an emergency fund, or other savings that you do not need on a day to day basis. A brick and mortar savings account will never become obsolete, it is far too convenient, even though the rates are traditionally much lower. Keep just enough in a brick and mortar account to utilize it conveniently, and keep the substantial savings at an online bank to earn more in interest. For most people, two accounts is now the necessity.
Peer to peer lending
Typically we would think of obtaining a loan from the friendly loan officer at the bank, rather than going to the general public for a loan. But new online lenders use eBay style bidding to allow people to get loans at rates they would have never previously received.
The old banking standard of using a credit score as a risk assessment hurts many new borrowers with healthy budgets but limited access to credit. Peer to peer lending is as easy as eBay, people bid on loans based on loan amount and interest rate, ultimately driving down the interest rate for the consumer.
This solution is great for both borrowers and investors. A borrower can get a 3 year, lower interest loan from thousands of people across Prosper.com who can lend as little as $25 per person. With a combined effort from the community, you can get access to a loan of up to $25,000 from people who are just like you. No need to go through the anxiety of heading off the to nearest corporate bank when there are thousands of people willing to help out in a time of need.
For investors, Prosper offers a great investment. A combination of investors spreads out risk and allows people to lend to more borrowers at one time. The creditworthiness of the borrower is shown next to their ID and many borrowers choose to open up their budgets to scrutiny. In most cases, it’s graduated college students who want to consolidate student debts and lower their interest rate.
Prosper.com manages all billing and credit bureau information. One payment is made to Prosper each month that is then distributed between all the investors. This style of lending lowers the closing costs and fees that comes with traditional borrowing and allows people to help others. The returns are rather splendid as well, as P2P lenders have some of the lowest delinquent repayments. Whether investor or borrower, there is a lot to gain from peer to peer lending.
Raise your insurance deductibles and feel safer
Insurance is one of the most necessary evils known to man. Insurance companies profit by making the odds and setting premiums so that what the take in is always higher than they pay out. Over the long run, it is likely that you will pay much more to an insurance company than you will ever get back in return.
Insurance companies accept the risk of wrecking your car, or damage to your home, by accumulating it with thousands of other cars and homes. The risk of millions of cars across the country being totaled all at the same time is practically zero. With this in mind, disasters do occur and insurance companies have been known to make large payouts. The fact is, insurance companies take in a lot more money than they ever pay out. There is a reason that insurance payments are called “premiums.”
The deductible, or the amount that you have to pay when damage occurs, is the key to how much you will have to pay each month in premiums. Most damage to cars and homes is rather low. Of course a windstorm may knock off a few hundred dollars in roofing shingles, or a fender bender might cost a thousand dollars to fix. Thus, the question one must ask themselves is, how much should the deductible actually be?
Raising an automotive insurance premium from $500 to $1000 is one of the best investments you can make. Often times, this will drop rates by as much as 25% while only costing you an additional $500 in case of a serious accident. Even with a premium of $1000, damage of $5000 will only cost you $1000 out of pocket, with the remainder coming from the insurance company.
The more risk you are willing to accept, the less you will pay in the long haul. The difference in payments between a $500 deductible and a $1000 deductible will allow you to save the excess in the event that an accident does not occur.
