Friday, January 31, 2014

Remove the Debate from Personal Finances

This is part 1 of 14 of my series on the 14 ways I am changing my life in 2014.

As promised last week, I am going to jump into the details of all 14 of ways I am changing my financial life in 2014, one way at a time.

#1 on that list: Clarify priorities to render financial decision-making automatic, not a daily debate.

Financial Priorities
Financial priorities and the decision-making process are complicated with human emotion, ego, obsessions, and sometimes even addictions. After all, Dave Ramsey has an entire radio show dedicated to helping callers (and listeners, indirectly) prioritize what they should do with their money. Should the caller pay off a student loan or save for a down payment on a new home? Each caller describes a unique situation, but Dave has his set of 7 baby steps, or financial priorities, to clarify how each dollar should be spent.

My Priority List
So, here are my priorities, a little different than Dave's and anyone else's list that I've seen. They are in order of importance. I make sure that each one is managed/handled/resolved/funded/ each month before I allow any other money to go toward the next one.
  1. 10% of all income to Tithing, at least another 5% to charitable causes.
  2. Pay for all monthly living expenses while working to optimize the all expenses, meaning I try to focus as much of my spending as possible into things my family values (defining and living by family values is an entirely separate post for another day). This includes a small "slush" fund, or fun money, for each spouse to spend with zero accountability to the other.
  3. Set aside money for expenses that hit my checking account less frequently than monthly, like annual life insurance premiums, vacations, Christmas, etc. Then I am ready to pay for them when they do come knocking.
  4. Make sure I have enough money for all of next month's financial obligations, learning to live on last month's income.
  5. Put all excess funds towards paying off all debts except the mortgage on my residence.
  6. Put in minimum required to receive maximum match from employer's 401(k).
  7. 6 months of living expenses in an emergency fund, including 1 month already reserved for next month's expenses as mentioned in #4 and food and other commodities storage. 
  8. Fund Roth IRAs and retirement to a specified amount each year.
  9. Save up to $200/month saved for kids missions (Why no college savings in a later post)
  10. Set aside money for anticipated, larger-item purchases, like a car.
  11. Put any excess funds toward paying off the mortgage. I still have a ways to go on this one, so I am not executing on any priorities beyond this point.
  12. Boost amount saved for kids missions.
  13. If kids missions are funded, consider saving for kids' college and other one-time expenses, like weddings. If my wife and I think we might want to try and serve a mission before we can pull money out of retirement penalty free, then we might also save that under this same premise.
  14. Not sure what to do beyond this point. It is several years away. I have lots of ideas, and I'm sure we'll be ready to make some new decisions by this point, anyway.
The Monthly Process
Now, here is my monthly process that I have started to follow like clock-work, the "automatic" decision-making process. I sit down with my wife on about the 2nd of every month. We start by reviewing how we did on each of our priorities during the prior month and make sure our daily spending decisions are supporting, but circumventing, the already-decided-upon priorities. We also discuss variances from our plan and make adjustments to our future assumptions. Next we plan for the current month by going down our list of priorities:

1. 10% of all income to Tithing, at least another 5% to charitable causes - Since our income can vary from month-to-month, I make an estimate of what it will be, then we pay our tithing and other donations at the beginning of the month. Then I true-up our actual earnings with my estimate at the end of each month to make sure I didn't underpay. If I did, then I add it to the payment I make at the beginning of the next month. I have a simple spreadsheet I use to keep track of this, and I update it every month.

2. Continuously work to drive monthly living expenses down while directing as much of that spending as possible into things my family values - I'll be honest. There is some negotiation that happens each month in this area. But it is a good, healthy discussion. I don't like to call it cutting expenses. I prefer to call it OPTIMIZING expenses, meaning we focus on the best use of our resources to optimize the outcomes we desire. More on this in a later post.

3. Set aside a monthly amount for each less-frequent-than-monthly expense. This move solved so many of the budgeting issues I had in the past, primarily because it will be really hard for anything to "bust" our budget now. We make sure we don't have any surprises for which we know we can plan, like Christmas, annual life insurance premiums, vacation, etc. More on this in a future post.

4. No debt except mortgage. Next I use any extra funds to pay off any debts except the mortgage on my home. In January I resolved my final non-mortgage debt, a loan I took from my 401(k) plan.

5. Put in minimum required to receive maximum match from employer's 401(k). Once steps 1-4 are handled, I need to start paying myself. If I defer 5% of my paycheck into the 401(k) plan, my employer matches 80% of it into the plan, or a 4% raise. That is 4% I never would have received, or an immediate 80% return on my investment. It would be foolish not to take advantage of this great benefit. 4% is the maximum amount of my paycheck my employer will match, so I defer 5% automatically out of each check. I will talk more about how I invest my 401(k) money and other retirement savings in a future post.

6. 6 months of living expenses in an emergency fund. This is the sanity money, and it is no small amount. With a wife and seven kids life is not cheap! This money allows me to have security when I want to take risks and enjoy a sound night's sleep knowing we have a runway of cash that is easily accessible if needed. I just accept the low interest rate from my online bank's savings account in exchange for preservation of capital (FDIC insured) and accessibility. If I ever have to draw this balance down, I will not move beyond this priority until it is fully-funded again.

7. Fund Roth IRAs and retirement to a specified amount each year. I have a specific amount I am trying to set-aside every year, but only after the first 6 priorities are in shape each month.

8. $200/month saved for kids' missions. This is a small amount that I hope to increase dramatically after the house is paid off, and I only do it if the earlier priorities are dialed in.  

9. Pay off mortgage. This is the "beast" priority. I have a ways to go, but a clear plan. Every free dollar I have every month is going toward this priority. I will not see priorities 10 and beyond for a while. But occasionally I think about what life might be like without a mortgage payment. All of that cash, plus the extra we've been using to get it paid off, can now be applied to even greater causes. That's what keeps me motivated.

The financial priorities represent decisions we have and will continue to make. If we ever question how we will spend money in the future, we can just refer to our map of priorities and it will be out guide. Although these may need to be adjusted from time to time, having financial priorities allows us to avoid the need to re-make decisions and have a clear path on what we do with every dollar each month.

Friday, January 24, 2014

14 Ways I am Changing My Financial Life in 2014

I think accountability is a good thing. In fact, I wrote about it last year here: Accountability: The More Personal and Public the Better. With that post I disclosed some specific things I was going to do in 2013 to improve my health and fitness, and it helped me accomplish my goals. Knowing that I had detailed my plan for improved health on the internet for the world to see (well, at least those who visit my blog) helped me stay motivated to do what I said I would do. My wife thinks I'm a little crazy, but it works for me.

In the spirit of public accountability, I am going to disclose the priorities and goals I have in place that will help me develop better personal finance habits in 2014. Sadly, I've neglected this area of my life a little; it's time to change that. I am not dropping what I worked so hard to achieve in 2013. Rather, I will maintain the good habits of health and fitness I acquired last year while developing new habits in the area of financial health this year.

The List
Hopefully this list will validate what you are already doing, or it may give you some ideas of where you might want to improve. It may motivate you to keep doing what you're doing or consider making some changes. This list is just a summary of each priority/goal. I will write future blog posts that get into the details of each, including my experiences with implementing each of them.

[Author's Note: As I write the future blog posts, I will link each post to to this list]

1. Clarify priorities to render financial decision-making automatic, not a daily debate. In the past I remember feeling paralyzed by certain decisions. Should I put every extra dollar I have into paying off my house before I start to save for retirement? Where does saving for college for the kids fit in? When is it okay to pull money from our emergency fund? I've wrestled with all of these questions and more, and that wrestle has resulted in a clear, concise set of priorities, in specific order that I use as a guide when deciding where to put every dollar that comes into my bank account.

2. Stop using debt in all shapes, sizes, and forms. The float on your credit card is debt! Borrowing money from yourself (through your 401k) is debt. Whatever its form, I've decided: NO MORE. I've already written some of my experience with this here: I'm Turning My Credit Cards in Guitar Picks.

3. Pay off all debt, except for the house, and get one month ahead. Much more to come on this subject. January has been a great month, and I can't wait to detail how I've pulled it off.

4. Build up the emergency fund. The "experts" seem to recommend between 3 and 12 months worth of living expenses. This should not be an arbitrary number. I've come up with my own philosophy on determining how much I need and the savings vehicle(s) where I should keep it.

5. Switch to an online-only bank. Enough with the local credit union and their behind-the-times technology. I want to bank where I don't have to go into a branch or office. That is the way of the future. And I'm earning better interest, too. In a future post I'll detail how I decided which online bank and how it has gone so far.

6. Overhaul our family budget with new budgeting softwareMy attempts in the past to create and stick to a budget never got the traction I wanted, and I always struggled to budget for the infrequent and non-recurring expenses. I am on a mission to change that. Funny how I have successfully done that for dozens of large business, but never applied it to my own household finances. And I found the best software of all for budgeting personal fiances. I will tell you about it in an upcoming post!

7. Update my Personal Financial Statement (PFS) and review trends. This is one of the two main methods to determine your overall financial health. It is important to track and hold yourself accountable to improving it every year. I've gone back as far as 2005 and have some interesting trends to report along with some lofty goals to shoot for this year.

8. Pay more attention to my 401k investments. I used to help people invest their money. Yet I've spent less than 5 total minutes selecting and managing my 401(k) account. I know with a little more TLC I can improve performance and the ultimate outcome.

9. Retirement Savings. Is a Roth or Traditional IRA better? What is the best way to invest the money? How do I make sure I will have enough to enjoy a comfortable retirement? I have found some solutions here that I am excited to share.

10. Set-up automatic investment for kids. First I had to have a serious conversation with my wife about what, if any, obligation we felt toward helping our kids with college, missions, etc. Then I had to decide what to do about it. We have agreed on an "introductory" plan we are going to try out for a while, then evaluate from there.

11. Set-up savings for planned and unplanned major purchases. I am a planner. My wife is more reactive. We make a great team because of this difference and our other differences, primarily because the middle-ground we find seems to create the best results for both of us. However, I have fallen too much to the "reactive" side of the spectrum. It's time to plan and save more for purchases we know are in our future.

Quick Author's Note: Just so you know, my wife is brilliant. My first draft of this list had a total of 17 ways I am changing my life in 2014. She took one look and said: "It should be 14 not 17 ways in 2014." So I merged a few into others and now it just sounds way better!

12. Review food and commodities storage and bring it up-to-date. Almost 10-years ago I put some money and time into building a storage of food and commodities that we could call on in an emergency. At one point we had enough to last an entire year. As we've used some of it and as our family has grown, it is time to take inventory and get it back in shape.

13. Review, tweak, and renew all insurance programs and legal documents. How much and what kind of life insurance? High deductible or traditional health insurance? Do I have enough disability coverage? I am in the process of a comprehensive review of all insurance as well as my last will and testament, living will (with health care agent appointment), and power of attorney. I hope to share much more on this topic soon.

14. Taxes. I am getting a big refund this year. #FAIL. Getting a refund means I did not plan well for the 2013 tax year and let the government borrow my money. I have found some great tools to help correct this, and I think I am also going to try and file my own tax return this year. I am also a big proponent for the tax savings available to those with self-employment income. Even if you have a full-time job from which you receive a w-2, a little self-employment income on the side can save a LOT. Much more to come on that subject.

What I Learned...still to come
As I mentioned above, I plan to write much more about each of these items from the perspective of my personal experience and journey. Let me know if you have any thoughts or comments. Thanks for reading!

Friday, January 17, 2014

I'll Never Borrow From My 401(k) Again

A little more than 1 year ago, I took a loan from my 401(k) plan. Today, I paid it off early. I will never borrow from my 401(k) again. Here are the lessons I learned and why I'll never go back.

What is a 401(k) Loan?
Quite simply, it is sneaking into your retirement account and taking money out of it way before you're supposed to. And, you avoid taxes and penalties if you call it loan and pay it back, with interest, to yourself.

Missed out on nice growth
Although I had a nice bump in cash flow when I received the loan proceeds (I used it to put extra money down on our home), I missed out on a fantastic up-tick in the market. A quick analysis shows I missed out on almost 28% growth while I was paying it back to myself at an interest rate of 4.25%. So, my total cost for taking the loan was over 32% of the original loan proceeds. Here is a snapshot of what the S&P did while my money sat and watched on the sidelines (make sure to look at the green percentage in the bottom right-hand corner; that plus the interest I paid myself is what I missed out on).

Exposed to more volatility risk with little or negative ROI
When it comes to investments, risk is a major consideration. The more risk you take, the more potential return you can achieve. Because of the interest rate I was paying, the timing and frequency of my repayments, and the general volatility of the stock market, I significantly increased the amount of risk to which I exposed my money. Yet I had very little chance of earning a commensurate return. Sure, if the market was down 28% I could pat myself on the back. But the amount of additional risk could have wiped out some, if not most of those savings. Over time, the best way to manage investments is to minimize risk while maximizing the return. Clearly my 401(k) experiment was just the opposite.

Double taxes on interest payments
The interest I paid during the last 1.5 years was with after-tax dollars. So I put already-taxed money into a plan that will require I pay tax on it again when I take it out during retirement. Let's imagine I paid a total of $500 in interest up until I paid the loan off today. Assuming a 25% federal and 5% state tax bracket when I withdraw money during retirement from my 401(k), totaling a 30% tax bracket, that means I have to pay an additional $150 on my already-taxed funds. All of the sudden my low interest rate doesn't look so low any more and results in more overall risk exposure and erosion of after-tax earnings.

Emergency if you leave the company
Here comes the trickiest and riskiest part. If, for any reason, I am no longer an employee of the company, I have to pay back the loan or I am subject to early withdrawal penalties of 10%, not to mention the entire unpaid loan amount would also be taxable. I caught a glimpse of what this might be like last year when the company I work for was purchased by another company. To get everything organized correctly, we were all fired by the old company and then immediately hired by the new company. We started on the new company's 401(k) plan immediately, but the old plan treated me like a terminated employee and was going to report my loan as taxable and subject to penalties. Luckily I worked out an arrangement with the new company to avoid this, but the risk of this happening is very real.

Laziness and lack of discipline allowed debt into my life
Along with my credit card use, this 401(k) loan was probably my most irresponsible financial decision. And it all came because I got lazy and lost my discipline, neglecting the principles I had adhered to my whole life.

Done and done. Never again. Retirement investments are just that...for retirement. Have discipline, don't be lazy, and stick to the values of abhorring debt. If you are in debt, annihilate it with every spare dollar you earn until it is gone. If you are out of it, don't go back. Ever.

Saturday, January 11, 2014

Credit Card Use Erodes Your Emergency Fund

It has been almost 2 weeks since we cut up our credit cards, and I have some thoughts to share.

The Goals
I have two major goals for discontinuing my use of credit cards:
  1. Spend less - As mentioned in my blog post last week (My Only Use For Credit Cards in 2014), I hope to reduce my expenses by more than $1,000 in 2014, the amount of the rewards I earned for using credit cards in 2013.
  2. Reduce the amount needed in emergency funds - I will discuss this one below.
Working Capital
You may think that the concept of working capital only has to do with business cash flow, yet it has everything to do with credit cards and your personal finances. Let me explain.

I will use my recently cut-up American Express card as the example. The billing period ended about the 5th of each month, followed by a 25-day grace period until payment was due for all purchases made during the billing cycle. As long as I made my payment by the 1st of the following month, or the end of the grace period, I didn't have to pay any interest or any penalties...I got all that extra time for free, and I even got paid (in the forms of credit card points and rewards) for doing it.

If I bought my wife a Christmas present on December 7th with my American Express card, I would not have to pay for it until February 1st of the next year. That is about 55 days between the day I received the product and when I had to pay for it. Why do credit card companies give so much to make nothing on a guy like me who uses every day of the "float" but always pays off his balance every month? I think they are betting that, at some point, I will have an emergency for which I am not prepared, and they know I will likely not pay off my balance, incurring interest and fees.

So how does working capital and credit cards impact personal finances?

Corporate and Personal Finance
In corporate finance, the longer you can postpone paying for things the better. Anything that can be done to stretch out the days between when you receive goods and when you pay for them squeezes the need for cash to be consumed in the working capital cycle. Or, in other words, it makes cash flow look better and working capital turn over faster, both things that can increase the perceived value of a business. However, and this cannot be understated, it is a liability that grows with every day that passes.

Liabilities are risks...promising to pay for something in the future. Liabilities are debt!

In personal finance, a way to find some extra cash is to postpone paying for things. The 55 days afforded by my former credit card is an example. But is this a wise way to handle your money? I don't think so. You are exposing yourself to additional debt and you will need more emergency funds to properly mitigate the risk associated with this debt.

Emergency Fund
Experts recommend having as little as 3 months and as much as a year's worth of living expenses set aside in a liquid account (like a savings or money market account) for emergencies. I am comfortable with 6 months for my situation, all things considered. However, if for some reason I could not earn a living for some period of time, my six months of emergency funds wouldn't last me that long. Why? Because I would have purchases as many as 55 days old for which I still have to pay, and those are in line before the current purchases.

The conclusion: Credit card billing cycles and grace periods erode your emergency funds.

Getting Current
So, here we are in January. I have paid cash for everything I have purchased so far this month. I also have the debt from my December purchases that I am paying off this month, too. This is painful. I feel like I am paying for two months instead of just one, mainly because we were trying to put everything we purchased on our credit cards so we could maximize the rewards we could earn. I gave myself just one month to get current, and, although it is painful, it will be worth it. My net worth will improve. My emergency funds, if needed, will be able to serve their purpose for the duration designed. And I am one step closer to accomplishing my goals for fiscal fitness in 2014.

Wednesday, January 1, 2014

My Only Use for Credit Cards in 2014 - Guitar Picks

On December 30th, 2013, my wife and I cut up our credit cards to begin a journey that will last through 2014 and beyond. And what of the credit card remains? They are now guitar picks:

I made a goal for 2014. No, I am not going to learn to play the guitar. The picks are for my sons who play. I am committing that 2014 will be the year I become more fiscally fit. I won't share the specific numbers, rather just explain a little bit of my rationale and process as it relates to credit cards.

Author's Note: I hope you noticed that I used the word "goal" and not "resolution". I am not big on new year's resolutions, but I am very big on setting goals and action plans around accomplishing those goals. 

One Thing I Learned From Last Year's Goal-Setting and Improvement Process
At the end of 2012 I set some aggressive goals for improving my levels of health and fitness, which included tracking everything I ate, eating more healthy while cutting down on overall calories, exercising a ton, and losing some weight. I wrote about the beginning of the process here: Accountability: The More Personal and Public the Better.

New year's resolutions usually work like this: spend 5 minutes thinking of everything I want to improve about myself and my family, write it on a sheet of paper, and then possibly never revisit that piece of paper or my thoughts on the subject again for another year. In contrast, in 2012 I spent a lot of time preparing for and then accomplishing all of my goals in 2013, which included 2 triathlons. You can read about one of them here: Don't Stop Trying Something New: Journey to My First Triathlon.

Why Finances Next?
With solid health and fitness habits in place now for more than a year, I was hungry to take on a new challenge, something to really put effort into for 2014. I had some financial goals for my family in 2013, but I really didn't give accomplishing them much attention. No surprise, I am not happy with the results.

During December 2013 I began re-acquainting myself with and consuming as much content on the subject of personal finance as I could. I learned nothing new, but just reinforced principles that I have been a little bit lazy applying in my life for the last few years. This motivated me to make fiscal fitness my next area of focus.

You know how the landscaper on your street is the only one that hasn't put their yard in yet? I feel a little like that, that expectations for me (a business and finance guy) are higher than for others. Maybe it's because I deal with those things all day professionally that I have been a little neglectful. Whatever the reason, I have enjoyed getting back to the fundamentals and basics of personal finance.

Coming off a year in which exercising 1-2 hours per day was the norm, seeking greater fiscal fitness seemed easy in terms of an overall time commitment, but possibly just as challenging in terms self-discipline. Life has taught me that it takes consistent self-discipline and tenacity to change my behaviors and mental perspectives for the better, and even more discipline and tenacity to keep myself changed. All of this is a hard and uncomfortable process, so the effort needs to be worth the process.

Pros & Cons of How We Use Credit Cards
I have two credit card accounts, an American Express that is tied to a Costco membership and a Chase Freedom Visa. For the record, I have nothing against these companies. In fact, they have been good to work with. I always pay the full balance on each card at the end of each period, never incurring any interest or late payment fees/penalties. I have purposefully tried to push as many expenses and financial transactions through these cards to maximize points and cash-back rewards, amounting to over $1,000 in 2013.

However, upon evaluating the last 12 months, I think we could have and should have spent less. Not a lot less, but definitely less. In fact, some research states that consumers behave differently depending on their payment medium. According to cash vs. credit mindset, credit seems to draw consumers into benefits while cash keeps consumers focused on price. The bottom-line is this: it is likely that we all spend more when we use credit, even if we pay our balance off monthly and earn a bunch of points/rewards.

The Debit Card Gray Area
While the research is clear regarding cash vs. credit cards, the research doesn't appear to be as conclusive when comparing credit and debit cards. In today's digital world, I just can't bring myself to carry around cash and always use it to buy things. I do too much online shopping to think of cash as a legitimate comprehensive solution. But I am motivated enough by the possibility of spending less that dropping the credit cards and converting to debit card use along with occasional archaic checks and cold, hard cash seem worth a try.

The Challenge
I earned more than $1,000 in rewards and points last year. By using a debit card, archaic checks, and hard, cold cash, will I spend at least $1,000 less in 2014? It may be a little hard to tell, primarily because I am doing several other things this year to try and reduce spending and increase saving (which I may detail in future posts). Cutting up the credit cards and turning them into guitar picks is a bit dramatic, but so were some of the things I did last year to accomplish improvements in my physical fitness.

Results So Far
I have now gone more than 2 days without a credit card. And, it is very uncomfortable for me. I find I am already more focused on price and more conscious of how purchases will affect my goals for the coming year. We'll have to see if this continues.

What's Next
You have now been exposed to only a small portion of the entire plan I have in place for 2014. I have new accounts, debit cards, tracking systems, and other processes all lined up to make it all happen. If this post gets enough interest, I'll share more of the details and specifics along with the ongoing results.