Category Archives: Basics

Do You Work Work Work Everyday to Pay the Bills?

Do you ever feel like bills run your life?

It’s an endless cycle.  You’ve got bills.  So you work.  You get paid.  You pay your bills.  More bills come in.  So, you work some more.  But, the bills just keep coming.  Your cable bill goes up, then your electric bill jumps.  But, your pay stays the same.  It seems like there’s no end in sight.  Your sole purpose in life is to pay bills.

LunchMoney Lewis - Bills

How do you break this cycle and get control? When do you work for more than just your bills?  Well, you can’t just ignore them and hope they go away by themselves, because they won’t.  You have to take action.

Make a list

Start by simply making a list of all your bills.  Seeing all your bills on paper can be frightening.  But you may have forgotten about some of them or you may have just convinced yourself that some of them didn’t exist.  Putting things in writing is a great way to be honest with yourself.  Keeping track of bills in your mind, it’s easy to fudge the numbers and play games with the truth.  But, putting actual pen to paper makes it little more difficult to lie to yourself.

Look for easy wins

Now that you have all your bills out there on a piece of paper, take a good look.  Is there anything on that list you don’t need are could easily live without?  Maybe you forgot you had an old magazine subscription you’re still paying for or maybe you have a membership to that fancy gym in the high-end part of town that you’ve only been to once in the last 6 months.

Now pick off the medium wins

Is there anything you could trim down?  Maybe downgrade your internet speed one level.  Or, cut out one or two restaurant meals every week.  I’m not talking about anything extreme.  Just small changes you could make to your lifestyle that would be fairly easy to adapt to.

Add a little elbow grease for some tough wins

Are there any bills you might be able to re-negotiate.  Cable is usually a good candidate.  Every cable company offers deals.  It might be worth your time to call up and see if the person on the phone can hook you up with one of those specials.  Insurance is another bill that can be trimmed with a little research and a couple of phone calls.  Don’t be afraid to shop around.  Is there another insurance company out there that can give you a lower rate on your car insurance?  Maybe.  But, you won’t know unless you shop.

Be cautious about cold turkeys

Some people take one look at their bills and are so disgusted, they think they need to completely cut out all restaurants, cut out TV completely, go to the library to use the internet, and sell their car so they can start riding their bike to work everyday.  It’s called going cold-turkey and it might work for some people.  But, chances are, you’re actually setting yourself up for failure.  it’s like dieting.  If you start out by completely cutting out entire food groups and chopping your calories in half, you’ll probably run right back to the food a few months later.  On the other hand, if you approach your diet with slow, gradual, measured changes, your chances of succeeding in the long-run become much better.

Free money

Once you have all your bills written down and you’ve gone through the list with a fine-toothed comb.  You should find some extra money you didn’t know you had.  You can actually start setting some money aside for things like emergencies, your next car, travel, or retirement.  You’re no longer trapped working for your bills.

Bonds. What the Heck are They?

EE Savings Bond
By United States Treasury, Bureau of Public Debt [Public domain], via Wikimedia Commons
You may hear recommendations here and there about using bonds to diversify your portfolio.  But, what are these “bonds” of which people speak so highly?  A bond is a loan in which you, the purchaser of the bond, act as the bank.  The government entity or company that issues the bond takes your money and agrees to pay you back in a certain period of time with interest.  If you’ve ever voted in a local election, you may have seen a school bond on the ballot to build new buildings or a city bond to fund some sort of grand construction project.  You’re voting on whether or not to allow your school district or city to issue bonds to investors.

Safety Means Small Return

Generally, bonds are considered to be a safer investment than stocks, but don’t offer as big of a return.  In fact, bond prices tend to move in the opposite direction of equities.  So, when the stock market crashes as it did in 2008, bond prices tend to go up. When the stock market is up like it is now, bonds prices tend to go down.  Bonds help smooth out the bumps in your portfolio.

Price Factors

The price of a bond is generally affected by three factors:

  1. Interest rates. As interest rates fall, bond prices tend to rise.
  2. Inflation: As inflation falls, bond prices also tend to rise.
  3. Credit ratings: The higher the credit rating of the bond issuer, the higher the price of the bond.

You may have heard of junk bonds in the news.  These are bonds that are issued by an entity with a low credit rating and so are much cheaper than your average bond.  These bonds are very risky, but are appealing to some because of their potential for a huge return.  Before you run out and buy, keep in my mind the odds are very much against junk rated bonds going up in value.

Diversification Tool

The general rule a lot of investment advisors use when recommending an investment strategy is to invest your age in bonds and the rest in stocks.  So, if you’re 35, you would invest 35% of your portfolio in bonds and 65% in stocks.  Once you reach 70 years old, you’re bond percentage will have ratcheted up to 70%.  The idea behind this being, as you get older, you’re less able cope with the ups and downs of the stock market.

Do You’re Homework

Bonds aren’t for everyone, including me.  But, before you decide if they’re right for you, it’s a good idea to know what you’re getting into.  I encourage you to do some more research.  Talk to a few different financial advisors.  If you then decide in favor of bonds, I would recommend one of two strategies:

  1. Stick with an indexed bond fund – something that follows an average of bond prices.  This eliminates much of the risk of picking the right bond.
  2. Short-term U.S. Treasury bonds.  These bonds are very low-risk and are the preferred bond of Warren Buffet.  But, he doesn’t use them as a way to make money.  Instead, he uses them as a way to store his cash.

Square Six – The Final Square

Last time we talked about squares, it was all about gearing up for your retirement.  Now that you’re done with that, it’s time for the fun part – build up your net worth and buying stuff.

Here are six things you can start doing as part of square six:

1. Save for your next car.    

Remember that car payment you were sending off to the bank every month?  Well, now is your chance to be your own bank and make that car payment to yourself.  In five years or so, you ought to have enough money saved up to buy the used car of your dreams.

2. Save up for a house. 

Are you renting?  Start saving up a down payment for a house.  Somewhere between 10 and 20% is pretty healthy.  The more you can put down, the less you’ll owe to the bank.  If you’re feeling really aggressive, save up and pay cash for the whole thing.

3. Pay off your house.   

Are you on a 30 year mortgage?  Do you have an interest rate higher than 4%?  (I know this sounds like the beginning of a bad a late-night infomercial)  If you answered yes to either of these questions, you might consider refinancing to a 15 year mortgage and/or a lower interest rate.  Then, start sending some extra money to the bank every month and get that mortgage paid off fast.  When that mortgage is done, your risk of foreclosure drops to zero and you’ll have more money to spend on the other things in this list.

4. Start buying additional index funds on top of what you’re already buying for retirement.    

This is probably the single best way to keep your net worth growing.  Open up a brokerage account and buy index mutual funds or ETFs.  Do this and you’ll be well on your way to financial independence.

5. Save up and buy rental property.  

This one is a little more challenging, but if you like the idea of owning real estate, rental property is a great investment.  Just make sure you save up the money and pay cash for your properties.  Otherwise, the risk of mortgaging these rentals can make you regret your investment.

6. Buy some fun stuff. 

You can also start saving for some fun stuff.  Is there somewhere you’ve always wanted to travel?  Maybe there’s a home renovation project you’ve had your eye on.  Perhaps there’s a charity you care deeply about.  Basically the world is wide open.  You can buy or do just about anything you set your mind to, as long as you save up for it first.

You shouldn’t pick just one of these things to throw your money at.  Divide your money up.  Do some fun stuff, but also do some wealth building.  Mrs. Pennypacker and I are currently working on numbers 1, 3, 4, and 6.  Once our house is paid off, we plan to add number five into the mix.

Square Five – Get Ready For Retirement

Last time we talked about squares, it was all about building up that emergency fund.  Now that you’re done with that, it’s time to get ready for retirement.  For some of you (myself included) that could be decades away.  But, in order to take full advantage of compound interest, you have to start saving yesterday.

If you stopped your retirement contributions to give yourself a boost paying off your debts or piling up cash, now is the time to restart them.  To retire comfortably, you should be putting away somewhere between 10 and 20% of your income.  I know it’s a lot, but trust me, you’ll thank me later.

There are three steps to a successful retirement contribution plan:

1) 401k up to your company match.  If your company matches a percentage of your 401k contributions, start by signing up for the full match amount.  You don’t want to turn down free money, do you?  If your company doesn’t offer a 401k or a match, skip step one and move on to step two.

2) Roth IRAs up to the max.  If you qualify (the IRS sets certain income minimums and maximums), start putting away the maximum allowable amount into a Roth IRA account.  If you’re married with dual incomes like me, you can typically open two Roth accounts, one for yourself and one for your spouse.  The nice part about Roths is, after age 59 1/2, you can either leave your investments alone or withdrawal any amount of money tax-free.  You can also pass a Roth on to your heirs after you die and they can withdrawal money tax-free – provided they meet certain IRS guidelines.

3) Max out your 401k and/or start a standard brokerage account.  Finally, if you still have more money to give to retirement, you can either max-out your company 401k, or simply buy index funds in a standard brokerage account.  With a 401k you get an instant tax break on your contributions.  With both a 401k and a standard brokerage account, you’ll have to pay taxes when you start withdrawing your money, which hopefully won’t be until after retirement.  The one thing I don’t like about a 401k is you have to start taking minimum distributions once you reach age 70 1/2.  The IRS won’t let you just leave your investments alone for the rest of your life.

I strongly encourage putting all of your retirement accounts on an automatic investment schedule and then promptly forgetting they exist.  That way, your investments can be left alone to do what they do best – grow.

So You Paid Off All Your Debt…Now What?

Square four is here.  It may have taken a while, but if you followed the instructions from last week, all those credit cards, cars, and student loans are paid off.  Now that you don’t have all those payments to make every month, you should have a good chunk of extra cash coming in every month.  Now, you may be tempted to run out and buy the latest LED television or a whole new closet full of clothes, but I have a different suggestion.  How about dumping a bunch of coins in a large room and swimming around like Scrooge McDuck from Duck Tales?

Scrooge McDuck Swimming In Money
Scrooge McDuck Swimming In Money

Okay, so maybe the swimming part is a bad idea, but you should still take a queue from Uncle Scrooge and start hoarding your money. In real life you need to be ready for anything, and a large pile of cash is the best way to be prepared.

So how much do you need?  Well, that’s up to you.  I good guess is somewhere between 3 and 12 months of expenses, but it’s going to depend on your personal situation.  Does your household have multiple sources of income and could you survive for a while if one of those incomes vanished?  If this is the case, you could probably get away with 3 months of expenses.  If you only have one source of income and you live pay check to paycheck, you might be better off putting away around 6 months of expenses.  If your job is shaky, you have large medical expenses looming, or you just feel a general insecurity about the future, you may be able to sleep better at night with 12 months worth of expenses set aside.

Where should you put this pile of cash?  A simple checking or savings account is fine.  Under the mattress at home is fine too, although maybe not the most secure.  The idea is not to invest this money and expect a large return.  Your main priority is liquidity – the ability to get to that money fast when you need it.

What should you use the money for?  It’s mainly there to help you through a period of financial hardship.  Whether it’s a job loss, a medical issue, a natural disaster, or the fridge suddenly dies.  The idea is to borrow the money from yourself, instead of looking to a bank, credit card, or family member.

Hopefully you never have to use the money in your emergency fund.  But, if you do end up using some money, your top priority should be to refill the fund as soon as the emergency ends.  You’re essentially acting as your own credit card, so don’t be dead-beat.  Pay yourself back as fast as possible!

Moving on to Square Three – Pay off Your Debts

Last week, we talked about square two and creating an emergency fund.  Now we’re moving on to square three – paying off your debt.  What kind of debt?  Everything but the mortgage – car, credit cards, student loans, unpaid medical bills, your parents.

Why?  Because in order to become financially independent and be able to retire comfortably, you need to invest.  An investing while you’re in debt makes no sense.  Why invest in tomorrow when you can’t afford to pay for today?  Besides the cash you’re burning every day in interest payments, you’re one job-loss or medical emergency away from repossession, foreclosure, or bankruptcy.  You don’t want to be forced to sell your investments at the wrong time in order to keep your car.

How?  One at a time.  There are differing strategies.  Some folks like the idea of paying off the debts with the highest interest rates first, but I like the behavioral approach touted by Dave Ramsey.  He calls it the Debt Snowball Plan.  You start by paying the smallest debts off first and then working your way up to the largest.  Don’t worry about interest rates, just get after the low-hanging fruit first.  Once you start feeling that sense of accomplishment from paying off the smaller debts, the momentum will build, and you’ll be motivated to continue on and pay off the larger ones.

Paying off debt takes money.  So, what if you live paycheck to paycheck?  Just like with square two, you may have to do some uncomfortable things to get some traction.  Cut unnecessary expenses, sell things, get a second job.  Also, if you’re contributing to a 401k, stop.  You don’t need to be saving for retirement when you’re trying to climb out of debt.  Keep in mind that as you pay off your debts, the money you were using to make those monthly payments goes back into your pocket.  Now you have even more money to throw at those larger debts.

Remember, the sacrifices you make are only temporary.  Once your debts are paid off you can go back to buying name-brand Cheerios.  Although, the Walmart brand tastes pretty good to me.