Wednesday, September 3, 2008

It's Not the Principle of the Thing, It's the Money

If you haven't already heard, we've managed to get an acceptable offer on our condo, and we've had our offer on a new place accepted. (Insert plea for moving help here.) The new house is really nice and I think we got a very good deal on it. It certainly helped that the banks were falling over themselves to get us to select them for our mortgage. We have excellent credit, and Gorgeous Wife had the lenders clamoring to one-up each other to get us the best deal.

It reminds me of a certain mortgage broker that runs ads that say, “When banks compete, you win.” Those ads conveniently omit the fact that the banks are competing already, whether the broker exists or not. It's not that hard for a reasonably intelligent person to do what the brokers do, without having to pay the middle man.

Anyway, with the economic climate the way it is, the banks are desperate for someone who is a good credit risk, so Gorgeous Wife had the mortgage agents eating out of her hand. (Well, if you can call begging someone to fork over thousands upon thousands of dollars of interest over the next thirty years “eating out of one's hand.”) In the end, Wells Fargo dug the deepest, even though they could no longer offer us the employee discounts that we got with our current mortgage, when Gorgeous Wife still worked there.

We're not rich. I don't make six figures, not even close. We've not inherited lots of money from wealthy relatives, nor experienced any windfalls from investments. Yet I get the impression that some people think that I go home each night, dump a briefcase full of benjamins* on the floor and roll around in them. They seem surprised that we have no consumer debt, or that we bought our car outright with a check instead of with credit.

We aren't financial geniuses. We just follow a few common sense guidelines that keep us out of trouble. They're nothing revolutionary or earth-shattering, but I'll share them here, since they might be useful for others. (This would be a good time to point out that I disclaim any responsibility for the results of following this advice. I can't see any reason why it would be harmful, but I'm not a finance professional.)

  • Pay God first. Seeing as everything you get comes from Him anyway, it'd be rather miserly to not be willing to tithe. You'll need His help to make sure you get through the tough times, so make sure that you put Him first.
  • Know where your money went. Track every dollar you spend, including cash transactions. If you use a credit card, treat that transaction as if you already spent the money. Always take receipts, and log them in religiously. By doing this, you will be able to tell how much money you have available at any time.
  • Know where your money will go. Make a budget. Figure out how much money you need for each category of expenditures, before you spend it. (This is easy to set up if you've been keeping track of expenditures.) It might seem onerous, but it's not so bad once you get into the habit, and it's positively liberating to actually be able to make financial plans and be reasonably certain that the money you need for those plans will actually be there. There are many software packages (some of them free) that can help you organize your budget, but it's not difficult to bang one together yourself if you've got some spreadsheet chops.
  • Prioritize expenses. I generally divide expenses into four groups: essential, important, useful and frivolous:
    • Essential expenses are those that are required to feed, shelter and clothe your family, and attend to their medical needs. As will all the categories, you may be able to find (and should look for) ways to reduce these expenses, but they generally cannot be eliminated. These expenses must always be paid first.
    • Important expenses are required for your continued financial well-being. They're only slightly less important than the essential expenses, in the respect that they won't matter if you're dead, but if they're neglected, you may wish you were. Insurance and debt payments fall in this category, as would expenses that directly affect your ability to bring income (car-related expenses, for example). Money put into emergency funds or other important savings accounts are also considered important.
    • Useful expenses are practical but technically optional. They may include purchases that will reduce your future expenses (a new water heater, for example) or provide a significant benefit to your family (such as repairing or replacing an ailing vacuum cleaner).
    • Frivolous expenses serve no purpose other than enjoyment or convenience. Most electronic gadgets and decorative items fall in this category, as do movies, eating out, cable TV, fancy clothes, etc. Things in this category are generally the first on the chopping block when cutting expenses.
  • Take a hard look at where you spend money, and figure out what you can cut. You should try cutting costs in all categories, but generally frivolous expenses should be cut first. It can be something of a morale killer to cut out fun money completely, so some discipline may be needed. If you can make the numbers add up and still keep one small frivolous expense, it may help to use that as a reward for “being good.”
  • Cut expenses until you spend less than you make. This would seem obvious, but since many people don't track their expenditures or make a budget, they don't really know how much they are spending, and therefore have no idea when they're hemorrhaging money. There may be months where you might spend more than you make, but in a well-run budget, this should be the exception, rather than the rule. Ideally, there should be money left over in your budget to save or throw at debt.
  • Avoid using credit cards. Credit cards make it far too easy to spend money you don't have. Find some way to make sure you don't use them casually. This takes some discipline which you might not have initially, so you may have to resort to more creative/drastic strategies, such as simply cutting them all up. Some people, who can't bring themselves to shred every card (ostensibly for use during emergencies) prefer freezing one, literally. Having to go through the effort of thawing the card (microwaving ruins it) makes some people think again about whether they really need the thing they want to buy with it. (Of course, this doesn't deter online credit card usage, so your mileage may vary.) If you do feel that you should use a card, don't spend more with it than you can pay off that same month.
  • Save for large purchases. The desire to have something now leads people to use credit for large purchases. But using credit instead of saving means that the interest is working for your creditor instead of for you. Missing payments quickly causes significant problems, whereas there is no such risk when you save. It may mean you'll have to do without something you want for a while, but the long term benefits are typically worth it. Writing a check for our car instead of getting it on credit was one of the best financial decisions my wife and I ever made, even if it meant we had to save for months and deal with the inconvenience of taking our groceries home via light rail.
  • Create an emergency fund. Now that you know how much money you have, how much debt you have, and where your money goes, the first step towards changing your situation is building an emergency fund. Having a bit of extra money in the bank makes you more tolerant of unexpected fluctuations in your income or outgo, and eliminates the need to resort to exorbitant “quick money” services. Start by working up to $1,000. Once you've eliminated your debt, increase it to cover at least three months of expenses.
  • Throw every cent you can spare at debt. If you have debt, it will be sapping your financial strength every day that it still exists. Now that you've got your emergency fund, it's time to attack debt with extreme prejudice. I'd suggest paying the minimum on all debts except the one with the highest interest rate, and throwing everything you've got left at that one. Some people, such as Dave Ramsey, advocate attacking the debt with the smallest outstanding balance first. While this may not be the best thing to do mathematically, an early victory may be the morale boost you need to help you stick with the program. Once a debt has been cleared, take the money that you were using for that one each month and throw it at the next one. Continue until you are debt-free.
  • Save for retirement. Once you're debt free and have a good emergency fund, you'll be breathing a lot easier. Now it's time to make sure you'll have money for retirement. Pretend that you're never going to see a penny of the money you're paying into Social Security. (With all its problems, that may well be true.) If your work offers a 401(k) (especially if they will match your contributions), start contributing to it. If you can afford to contribute more than the 401(k) plan allows, put the balance into an IRA.

If these tips make sense to you, I'd suggest listening to Dave Ramsey on the radio. He has many great ideas for increasing your financial freedom, such as his “Baby Steps” program, some of which is incorporated into what I wrote here. It's a little discipline and a little common sense that adds up to mastery of your money instead of money mastering you.

* It took a fair amount of effort to figure out whether the term benjamins ought to be capitalized. Wiktionary eventually resolved the dispute to my satisfaction.

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