Reader Question - Credit Cards

Why do people use credit cards?

If you have financial self discipline, using a credit card can be much safer than using cash or debit cards. Credit cards offer you better protection from fraud. They are also setup to protect your rights as a consumer because you can leverage the credit card company against a merchant who sold you a defective product. In a previous post, I discussed 4 Reasons You Should Use A Credit Card.

Many people are conditioned to avoid credit cards at all costs. This is a good strategy if you have no financial discipline–just a like an alcoholic should steer clear of even driving near a bar. If you treat your credit card like a checking account and keep track of each purchase as if the money has already been removed from your checking account, you can get the benefits of using a credit card while avoiding the dangers.

Productive Finances Checklist

Here is a checklist for your financial productivity. Most of these things seem minor but taken together they really add up and can make a big difference in how efficiently you are using your time and money.

1. Are you using direct deposit for your paychecks? — If you are still manually carrying a check to the bank or putting it in the mail stop! Direct deposit will get your money to the bank faster so you start earning interest as soon as possible. Even if it only saves you 5 minutes every two weeks, that is an extra 2 hours each year you can spend on something more important.
2. Is your money in the bank earning at least 4% interest? — If not, look for a different account. There are a many banks out there with savings accounts earning at least 4%.
3. Does your checking account earn interest? — If not consider if you should switch to a different type of account. Sometimes combining your checking and savings into a single account will get you over certain minimums and allow you to earn more interest than either account could separately.
4. Are you paying any unnecessary fees to your bank? – Watch out for fees. Your bank should be paying you for the privilege of keeping your money, not the other way around.
5. Have you maxed out your employer contribution to retirement? — Many employers offer some type of matched retirement savings plans. If you put in 3% of your income, they will match it. (The best retirement plan I had matched 7%.) If you work offers this and you aren’t taking advantage of it, you are basically throwing money away. Sometimes companies don’t publicize this information very well, so be sure to check the employee handbook and any information on retirement benefits.
6. Do you have any old credit cards that should be canceled? — You might be surprised how many credit cards you have–especially if youi tend to sign up for those promotions where you get 25% off your purchase if you sign up for a credit card at Target or JCPennys. If you have cards you aren’t using you should cancel them so they don’t show up on your credit report and to reduce your chances of having to deal with fraud.
7. Are you using bill payment? – This is a time saving feature just like direct deposits. In my opinion if your bank doesn’t offer this, you should switch banks to one that does. Many places offer free bill payment services. If they can directly wire money to the vendor they will. If not they will manually cut a check and send it. Bill payment saves you postage and makes it easier to manage your bills directly on your bank’s website.
8. Is your banking password secure? — If you read the fine print, most banks aren’t liable if someone breaks into your account because you didn’t have a secure password or had some type of spyware on your computer. Make sure you bank password is something secure. If they offer one of those security keychains with the changing number, consider getting one of those.
9. If you were to die, could your spouse easily find a list of all your accounts? — This is preparing for the worst case scenario, but if you handle most of the finances and you were to die a very small amount of planning now will make things easier on your spouse. A list of bank accounts and insurance policies could make things much easier when you are gone.
10. Are you taking advantage of FLEX and HSA plans? — Some employers and insurance plans offer these types of accounts as a way of setting aside pretax money to use for health care. The rules are fairly liberal and you can use these account for a variety of things including contact solution and aspirin. If you know you will have some medical expenses, these can be good ways to plan ahead to lower your tax burden.
11. Are you taking advantage of preventative healthcare? — Insurance companies realize that it is much cheaper to treat problems when they are small. Many plans include routine checkups and office visits to encourage you to have things checked out early on. Some offer other wellness plans to encourage you to take care of yourself. Taking advantage of these plans can help keep you healthy and let you fully utilize the services that have already been paid for as part of your insurance policy.

Can you think of some key items that should be on this checklist? If so please contribute them to the comments.

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity. Watch for more financial posts in the future.

Working with Your Spouse Finacially

In the book The Millionaire Mind and The Millionaire Next Door, the authors point out that millionaire’s tend to marry people who support them financially.  One of the easiest ways to wreck your financial plan is for there to be competition between a husband and wife financially.

If you have ever heard a couple say things like, “well you bought a new dvd player, so I can go buy a new dress” or “you spent $300 at the mall, so I decided to go buy a new television” you know what I’m talking about.  If a members of a marriage feel like they are in competition with each other for spending, they are off to a bad start.  Here are some simple tips to avoid this type of competition.

• Regularly discuss financial goals — If you are both headed toward the same goal financially it is much easier to work together.  This can be saving for a vacation, saving for retirement or getting ready to start a business on your own.
• Give each person a fun budget – Some couples find it is beneficial to give each person a budget for fun stuff each month.  As long as each of them stay within their budget, neither feels like the other is getting an  unfair use of their combined money.
• Try to give instead of take – The ideal situation is when both parties are doing their best to help meet the needs and desires of the other.  This works much better than when both parties are doing their best to take as much as possible.  Of course this needs to come from both sides to work.  If one person (often the woman) is giving all the time and the other person (often the man) is taking all the time it can breed a lot of resentment.

The biggest key here is to have open communication about finances with your spouse.  A good way to start is to set some small financial goals that you can meet together.  Even setting a small goal of trying to save up a $2,000 emergency fund can be a great exercise in working together financially.

Do  you have any suggestions or tips that have helped you work well financially with your spouse? Please share in the comments.

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity.  Watch for more financial posts in the future.

Passive Income

Last week we talked about defining wealth in terms of long you can go without a job before running out of money. With this definition of wealth we can increase our wealth from two sides. One side is to reduce our spending the other is to increase our savings and our income that isn’t tied to work.

Money that you don’t have to work for is usually called passive income. This includes interest and other types of income that you get more or less automatically. Here is a list of some passive income sources:

• Interest income - Money that the bank pays you for the use of your money.
• Rental income - Real estate lease or other sources of income in exchange for the use of property.
• Royalties - Money for the use of intellectual property.
• Dividends - Profit distribution to owners of a company.

If you can increase your income from these types of sources it reduces your reliance on your job which (in our definition) makes you more wealth because it moves you closer to financial independence.

There are a lot of small things you can do to increase your passive income. For example, if you have a savings account that is currently earning less than 4%, consider putting that money in a bank with a higher interest rate. If you have an average balance of $5,000 per year this will give you an additional $200 per year in interest.

That may not seem like a lot of money, but if you consistently look for ways to maximize your passive income, it shouldn’t take too long to get to the point that one of your bills is paid each month from passive income. The beauty of this type of thinking is that it encourages you to not only increase your passive income, but also decrease your expenses. Instead of just trying to make more money you are striving to have more freedom by working from both ends simultaneously.

Are any of Productivity501’s readers actively trying to do this? If so, what steps have you taken to increase your passive income?

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity. Watch for more financial posts in the future.

Definition of Wealth

One of the most important things you can do in aligning your finances to be more productive is define what wealth means to you.  Obviously being wealthy is something of a relative term.  Someone at the poverty line in the US would be seen as extremely rich in other parts of the world.

The Rich Dad Poor Dad books give an interesting definition of wealth.  They say that wealth is determined by how long you can survive at your current standard of living if you quit your job today.  So once you stop getting  your regular paycheck, how long can you live off your savings and passive income sources before you go broke.

I think this is a very healthy description of wealth because instead of focusing on being rich, it focuses on having the freedom to do what you want while maintaining your quality of life.

Once you’ve come up with your definition of wealth you’ll start to see that there are multiple ways of achieving it.  With the definition above, you can become wealthy by making more money, but you can also increase your wealth by lowering your cost of living.

Lets say you normally spend $50,000 per year on living expenses and you have enough money in savings to go 6 months if you quit your job today.  If you change your lifestyle and drop your expenses to $25,000 per year, you’ve effectively doubled  your wealth.  You can now go 12 months without going broke (actually a little longer because your money should be earning interest).  If you work for a year and set aside the extra $25,000 you can now go for 18 months.

By working to increase the amount you make (and save) while decreasing the amount you spend, you can increase your wealth from both sides of the equation.  The trick is to lower your costs in a sustainable way.  You can’t just stop spending money, but you can cut out things that can be replaced with better alternatives.  For example, if your current entertainment is to sit and watch cable television, you could replace that with going on walks in the evenings.  It is better for you and will save you around $50 per month.

As your wealth increases so does your freedom.  If your wealth is 2 weeks (the amount of time before you’d go broke without a job) you are very much a slave to your employer.  If your wealth is 1 year, you have the opportunity to take career risks that other people just can’t. Once you get to the point where you can go 5 years without a job, it frees you up to make financial decisions like starting a business, taking a sabbatical, or taking a risky job with the potential for very high payouts in the future.

What is your definition of wealth?

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity.  Watch for more Wednesday financial posts in the future.

Subprime Problem Explained

Thanks to everyone who helped answer my questions in the previous subprime post I now have a much better understanding of what is going on. I thought I’d go ahead and explain it here. The first reason is to share with anyone who is interested. The second is so the financial wizards among my readers can correct me if I got anything wrong.

Over the past several decades home prices have been going up. This has made them a fairly safe investment. If someone can’t make their payments they can always sell the house–usually at a profit–and pay the mortgage company back. In order to create as many loans as possible, mortgage companies will take a group of mortgages and turn them into a special type of investment vehicle and sell them off. This gives them cash to create more loans. For example, they will take 1000 mortgages and sell the rights to receive payment off to other institutions. Since different institutions have different risk tolerances they take the investment vehicle and divide it into several different segments. The first segment gets paid first. The second gets any money left over and the third gets any money left over from the first and second segments.

So when money come in from people paying on their loans, it first goes into the green bucket. The green bucket is sold to institutions who want very little risk. If the people who bought the green bucket have already received their money the payment goes to the orange bucket and so on.

This makes the green bucket very very safe. 66% of the mortgages would have to go into default before it would matter to the people who own the green bucket. The orange bucket only requires that 33% go into default before they start loosing money. If anyone doesn’t pay, the red bucket starts losing money.

This arrangement is why there are companies willing to sell their investment for $0.30 on the dollar. If they own the red bucket there is a good chance they will get very little of their money back.

Originally I didn’t understand why companies would be willing to sell their mortgage backed securities for 1/3rd of their face value. As you can see they don’t actually own the mortgage, they own a position to receive the payment from the mortgage.

This is causing some problems because the people who will lose money if homeowner stop paying are not they ones who actually hold the deed. In at least once instance, courts have ruled that the banks who purchased the mortgage backed securities can’t foreclose because they aren’t actually the owners of the property. So there are people living in homes that they have simply stopped paying the mortgage on and it doesn’t look like they will get kicked out any time soon.

For people (like me) who would be interested in investing in real estate if the prices drop significantly, it doesn’t look like things have hit bottom. The housing market is going to stay relatively high until a bunch of foreclosures start flooding the market. This is already happening in Detroit and some other cities, but most home prices are still within 10% of where they have been in the last 3 or 4 years.

So did I explain it correctly? Are there any major points to the way these investments were structured that I misunderstood?

10 Signs You Will Be Poor

Here is a list of signs that indicate someone is likely to be poor in the future. If any of these apply to you, it might want to consider making some changes.

10. The only type of CDs you know about play music.

Not understanding basic investment tools is one sure sign that you will mismanage your finances. This is especially true because a basic financial education is so readily accessible on websites, through library books, etc.

9. Your bank account balance goes down each month.

You don’t need any fancy charts to see if your net worth is improving or decaying. If you usually have less money in your accounts each month then your lifestyle is not sustainable on your current income. You’ll have to change something to keep from running out of money. Until you make some significant changes, you will continue to become poorer.

8. You carry a balance on your credit cards.

Normal interest rates on credit cards are extremely high. If you are willing to pay 20% in interest each month, it is very unlikely that you’ll make wise financial decisions in other areas. Even if you do, the amount you are paying in interest is likely to offset any gains in other areas.

7. You leave money on the table.

Not participating in an employer matched retirement plan is one way people leave money on the table. Health savings plans and other tax savings setups are other opportunities you shouldn’t overlook. If you regularly skip over opportunities to get free money you are unlikely to do well financially.

6. You look forward to getting a large tax refund.

A large tax refund usually means you didn’t plan ahead correctly. Any extra money you gave the government is basically an interest free loan. If you plan correctly your refund should be very small or you should have to pay a small amount.

5. You notice the “cost per month” price on items.

If the first price you notice on a new item, is the cost per month you aren’t thinking like a financially responsible person. This is especially true on items that you shouldn’t borrow money to purchase like consumer electronics. For items like a car or house, you should make sure you can make the payments, but your starting point for determining if something is worth the cost or not should be the price not the payment.

4. Social Security is your retirement plan.

Social Security may still be around when you retire. It can offer some nice life insurance style benefits right now, but if your entire retirement plan is based on Social Security you aren’t thinking like a financially responsible individual. If this describes you, I’d suggest you immediately sit down and see what your projected SS benefit will be and decide if you can live off that amount. And don’t forget to calculate in 6% inflation which means $100 today will only have the purchasing power of $96 next year and so on.
If you were to get fired today, you would be broke in two weeks.

3. Your bank fees each month are more than any interest you earn.

This is similar to leaving money on the table. Financially responsible people pay attention to bank fees. If you are being charged $10 per month by your bank you should know why and you should have a plan for making that charge go away. Banks should be paying you for the privilege of keeping your money, not the other way around.

2. Your retirement plan projects receiving large inheritance.

If your parents or a relative leave you a large amount of money when they die that is great. However if that is your financial plan you may be in for some disappointment. First, if they are truly wealthy they are probably going to be more interested in leaving their money to someone who displays financial responsibility. Second, they may find other uses for their money. It isn’t uncommon for someone to spend their life savings on healthcare costs at the end of their life. With some of the newer technology being developed, it may be possible for people to increase their lifespan but at a very great expense. Don’t count on that money being there.

1. Your wheels cost more than your car.

It doesn’t just have to be the wheels on your car. Any time your financial priorities are out of balance it is a pretty sure sign you aren’t going to acquire any wealth. Other examples include: Your video game collection is the largest portion of your net worth. You don’t have any money to repair your car, but you a new plasma television.

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity.  Watch for more financial posts in the future.

Productivity and Finances

A lot of people tend to think of productivity in a vacuum.  They want to get more done.  However at the end of the day your work translates into money which translates into purchasing power.  Sometimes instead of just concentrating on how to do more work, it is more efficient to concentrate on the conversion process–how the work turns into money and then turns into things you need. 

For example, if you currently work for $50 per hour and  you are able to make a change that allows you to turn  your work into money at a rate of $75 per hour, you’ve increased your productivity by 50%.

On the other hand, if you can make your money go further you can also increase your productivity.  For example, if you live in an area where your housing costs are $30,000 per year and you move to an area where your housing cost is $15,000 per year (but your income and other factors are still equal) you’ve significantly increased your productivity.  The amount you have to work in order to pay for housing has been cut in half.

Don’t get so caught up in trying to do more that you miss opportunities for productivity other than just doing more work.

This post is the first of several Wednesday posts on finances.  Watch for more financially related Wednesday posts in the coming months. 

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