General advice for an imaginary average person

Personal finance advice comes in many forms, running the gamut from Dave Ramsey’s philosophies on getting out of debt to Suze Orman’s no-nonsense anti-stupidity spending advice. Opinions vary wildly as you stroll down the promenade from the broker, a salesperson, to the financial planner paid by the hour rather than commission. Mass media, however, must appeal to the masses, so unless you’re working individually with a professional, the advice you receive is geared towards the average individual.

I don’t know any average individuals. This concept is a fictional statistical human being, an amalgamation of a sample population, with no defining characteristics. Mass advice cannot cater to the most diligent or intelligent of the crowd, because invariably less apt individuals overestimate their abilities, attempt techniques designed for the more able, and fail. Thus, advice is often “dumbed down” or simplified to meet the lower qualifications of a larger group.

Take, for example, the case of the best way to pay off credit card debt. I call it the “Debt Avalanche” but it certainly wasn’t my invention. While there are exceptions, this method of debt repayment calls for credit card debt always being paid off by focusing on the debt with the highest interest rate first. But people don’t always want to take this approach. They may receive more “satisfaction” by paying off the debt with the lowest balance first, which they believe will motivate them to continue paying off debt. Money, after all, is emotional more than it is mathematical.

Unfortunately, it’s this mindset which helps many people fall into debt in the first place (or repeatedly), and it is not correct. The best way of reaching a specific financial goal will always be the mathematical way. If not, your true goal is not purely financial. For example, is your true goal to get out of debt quickly and efficiently or is it to feel good about your debt situation? You’ll feel better in the end knowing you took less time and spent less money to get out of debt. If not, then perhaps you haven’t learned much of anything and will find yourself succumbing to the “emotions” of money again.

There are legitimate places for emotions when dealing with money, but debt reduction is not one.

Self-limiting philosophies and beliefs

You may hear that “doing what works for you” is the best way to approach a financial situation, but it’s often not a good idea. Doing what works the best mathematically is the ultimate approach. Other approaches may help you reach your goal, but not in the best way possible. “Doing what works for you” is an admission that you feel you have no need to improve yourself. This philosophy tells the world that you’ve learned everything you need to learn and are satisfied with your choice, even though you know it may not be the best. Or worse, if you have not learned all you need to know about your situation, you may not even realize that what you’re doing is in fact “not working.”

“Doing what works for you” is one of a number of self-limiting philosophies, excuses that people will use to convince themselves that they don’t need to strive for excellence. Here are some others:

“Luck and chance affect me more than my effort and skills.” Do you attribute a missed career opportunity to bad luck or not enough hard work? When you received a good grade on a college exam, was it due to the ease of the test or your preparedness? Those who attain their goals are more likely to be those who believe their own decisions and actions affect outcomes, good or bad. Those whose philosophy of outcomes is built around an internal locus of control have been shown to reach their goals more often.

“Anything is better than nothing.” When it comes to saving, reducing debt, and investing and planning for the future, I agree, you have to start somewhere. It is only a start. But if you believe that your financial condition in the future is important, the minimum is not enough. Don’t stop at “anything,” even if it is better than “nothing.” This is like saying it’s fine to feed your children one meal a day because one meal is better than no meals. Everyone is busy, but if the minimum is all you have time for, don’t expect results.

“At least I’m better than average.” The New York Times recently cited the Federal Reserve Board with an “average household credit card debt” figure of $8,565. Owe less than that and you’re in good shape, right? It’s unclear how that figure is determined. It may in fact be the average credit card debt of only households that have credit card debt. Include debt-free households in the calculation and the figure will drop. A number this high lulls many people into a false sense of security with the belief that with their balance of $6,000 in credit card debt, they’re “doing better” than most of the country.

This “security” leads to inaction and, in this case, to the glee of credit card providers, merchants, and manufacturers around the world.

Getting over it

The result of a lifetime with these beliefs is guaranteed mediocrity. While removing self-limiting philosophies doesn’t guarantee excellence and the ability to reach every goal, keeping these philosophies guarantees that you will not do your best. I do not know any man or woman with children who is satisfied with being anything but the best father or mother he or she could possibly be, so why are so many people satisfied with being an average personal financial officer?

There is usually a perfect mathematical solution to financial goals, like the Debt Avalanche mentioned above. Although Dave Ramsey says that most people have more success with a different, more expensive and time-consuming technique, that doesn’t mean you shouldn’t strive for the better solution. Just because perfection is not always attainable doesn’t mean that it’s worthwhile to stop striving for that approach and settle for lackluster results, especially if the better approach is not more difficult than the alternatives.

If you’ve found something that “works for you,” don’t assume that there isn’t something else that works better for you. Follow the best examples, not examples set by the fictional average individual. If your financial security is important to you, don’t settle for mediocrity. You won’t always reach your highest goals or always be excellent, but you’ll never be excellent if you limit yourself.

While I haven’t decided whether I’m making a habit of this, earlier today I asked Twitter users whether their current job is related to the field in which they earned a bachelor’s degree. The unique thing about Twitter is that responses are limited to 140 letters and spaces, so it’s a challenge to condense a full thought into one repspose.

Since I am assuming that those who responded publicly are fine with me posting their answers with attribution, here are some of the responses.

• Mmmeg: LOL! Majors were classical studies (Latin) & Spanish linguistics, minors linguistics & foreign lang. ed. I work at a fashion site.
• frugalbabe: nope. degree in psychology, minors in math and econ… working in the health insurance industry.
• ericyng: No. I work in IT.
• PenelopePince: B.A. in Interdiscplinary Studies: Linguistics, Spanish, French, Madarin & German; Minor in Music. I own a pet clothing business.
• nodebtplan: in Bus. Management—working as a recruiter now… so I’m in the business world. Kind of a broad degree. Working on MBA as well.
• Gingerlatte: BA Criminal Justice Yes. I work with women who are on post release by providing psychotherapy and group counseling.
• TheHappyRock: Yes, Comp Science. Although I do have an MBA now too.
• bripblap: have a BA in math, MBA in accounting and working in accounting – so half and half
• Private: I have a B.A. in Art History. I got an M.A. in the same field, then an MSLS. I’m back to working with art history now, but in a library.
• conedude13: Kind of. have a bs in ee but am programming c++ code but am considered an engineer in my dept. Confusing, but was doin civil eng b4.
• MrsMicah: English a field? i mean, English lit and libraries kinda go together…
• SunFinancial: BS, MS, and PhD all in EE, am working in that field.
• uppervalleymom: BA in Government,MS in Evaluative Clinical Sciences (public health-y)working PT at business school now, but was in nonprofit exec dir
• guppie: B.S. in biology, working in web development
• hank_MiB: BA in studio art. currently IT manager, but still do a bit of art on the side
• BurgBarbL: I majored in history and English and use skills from both of those in my field (publishing), if not in lit or history directly

By my count, there are seven polled whose work does not somewhat relate to their bachelor’s degree while ten who are employed in roughly the same field. There is a lot of pressure for high school juniors and seniors to choose a school and their career path or a “major.” Should there be so much pressure when students are still trying to determine their long-term goals and discover their talents?

I decided my career path early on in high school, without much pressure, but I eventually steered my life in a different direction, like a good portion of the people who responded to the poll. While my major remained constant throughout college, my minor floated from computer science to psychology to music management/music business, but during that time I was interested in at least two others.

This poll will tie into an upcoming article. Thanks to everyone who participated. Follow me on Twitter to participate in future polls.

The “condominium” (or “condo” for short) is generally seen as the missing link between renting an apartment and owning land with a house. Commonly, at least in my experience, a condominium is an apartment building in which the units are individually owned but the common spaces are jointly owned by all individual owners.

There is one primary advantage in owning a condominium unit above renting: your equity an an asset with a possibility of appreciation. There is also one primary advantage above owning a house and land, the probability of finding a comfortable dwelling for a lower price.

The disadvantages are numerous:

Lifestyle of dwelling. Living in a condominium is much like living in an apartment building. You are close to your neighbors, and no matter how things appear initially, the walls and ceilings are never as thick and sound-proof as they appear to be initially. If I want to hear the children living downstairs screaming at 3:00 in the morning, I’d prefer to stay in an apartment.

Price won’t increase as much as a single-family house. Even when the real estate market is in an upward trend, beneficial to sellers, the price of condominium units won’t increase as much as the price of houses. There seems to be an endless supply of condominiums. Apartment buildings are often converted to condos when the market is favorable to such a move. Houses, and more importantly the land they sit upon, are much more limited in supply. If you own a condominium you own a certain cubic feet of air within your particular enclosure. You do not own the biggest driver for appreciation, the land.

Association fees. The common areas in a condominium are owned jointly and are usually governed by a board of directors or another group of representatives. In addition to your mortgage and taxes, you will also be responsible for association fees. These fees ensure there is enough funding to mow the lawn, fix the roof, insure the owners against liability, and advertise unsold units.

Association rules. Rules vary from one condominium to another, but they are designed to keep the appearance of the buildings professional and uniform. This supposedly keeps property values higher. Don’t expect to be able to paint the outside of your unit in a way that reflects your personality. Your landscaping options are limited. In many cases, you won’t even be allowed to erect a small flag on your door frame or window. Some associations don’t allow pets.

While I reserve the right to change my mind, I’d rather skip “Apartment Living Part 2” when it’s time for me to “upgrade” my living situation. My intention is not to insult condo owners, it is only to discover what is best for me.

Photo credit: edkohler

Having an emergency fund, money set in an easily accessible location like a savings account earmarked for certain situations, is one of the first steps to being financially secure. This is common advice, particularly among financial advisers. Ideally, one wouldn’t tap the emergency fund at all. That sacrifices some earning power because even high-yield savings accounts lose ground to inflation. In return for that sacrifice comes some stability. With an emergency fund in savings rather than the stock market, you don’t have to worry about a potential loss if you need the money in a down market.

If you can plan in advance and protect yourself, you can help reduce the sting of an emergency.

There is, however, a difference in opinion about which circumstances qualify as emergencies. The biggest emergencies would arise with any event that eliminates an income source for an extended period of time.

Legitimate emergencies

Sudden job loss. For many people, the primary source of income, and thus the ability to pay for expenses, is a job. Most people in the United States trade their time and effort for a paycheck, relying on a company, small or large, to accept that time and effort and provide remuneration. When job loss is sudden, the primary source of income could disappear just as quickly. Very few of us are “entitled” to a severance bonus, providing a cushion to ease the fall for a period of time, so we must plan accordingly.

It’s dangerous to place your ability to earn income in a sole decision maker focused on a company’s bottom line. As an individual, we each must take our income into our own hands as much as possible, and that includes always being prepared for job loss. Part of that preparation involves having an emergency fund available, keeping a current resume, networking with colleagues, seeking recommendations, and studying the industry.

Even with preparation, the loss of a job can be damaging to your finances, and the effect can last long after you find your next job.

Death or medical emergency of a family member. While life insurance can help deal financially with death, it doesn’t cover everything. There is an entire industry designed around planning for death, but an emergency fund will always be necessary. As relatives age or gradually experience a decline in health, you have time to develop expectations and prepare financially, but unfortunately, death is not always this graceful. Emergency funds can be used to help pay for these hopefully infrequent events, from flights to visit distant family members to final arrangements.

Acts of nature. In New Orleans prior to Hurricane Katrina, residents wary about hurricane damage to their homes were encouraged to buy insurance policies covering wind and rain damage. Many insurance policies provided no relief following Katrina because the damage done to homes was determined to be due to flooding. According to USA Today, only one-third of homes carried federal insurance which included protection from flood damage. Many residence thought they were covered in the event of a hurricane, but the insurance companies disagreed.

A typical emergency fund with three to six months’ worth of expenses may not have solved all problems in this situation, but it could have helped. Natural disasters are not always as damaging as Hurricane Katrina, and planning for total destruction will in most cases be excessive, but when designing an emergency fund, it’s helpful to factor in what is likely for your location.

Car accidents. Auto insurance is generally helpful when it comes to covering for damage due to car accidents, whether caused by you or another party. Often, insurance won’t cover everything you need. Your emergency fund may need to at least cover your deductibles, but also fill in any gaps left after payments arrive. The fund can help pay for a new car if needed.

Surprise tax bills. While review and planning should prevent this occurring, occasionally the IRS finds something overlooked. It happens to even the most diligent. The IRS will usually allow a payment plan to extend repayments over time for an additional fee, but an emergency fund can help cover the liability.

Delay in income. I used to work for a non-profit which, before I had started working there, had a nasty reputation of not keeping enough funds in their payroll account to cover the paychecks for the ten or so on staff. I’ve had friends working for start-up internet-based companies who were asked to forgo paychecks for a time period for the good of the company in its initial building stages. With an emergency fund with three to six months’ expenses, you won’t be in danger of failing to cover your bills. Once the paychecks catch up, you will be able to re-establish the emergency fund.

If delays in income extend longer than six months—personally, I would only accept this from an employer for a month at most, if at all—it is time to find a new job, if possible.

Sudden relocation. Usually, if your employer determines that your job should move from New York City to Ogden, Utah, they will compensate you for your relocation. That isn’t always the case, and your option may be to forgo opportunities within your company and business by quitting your job or accepting the relocation and the accompanying expenses. The decision is personal, but it’s better to be prepared to face the consequences.

What does not qualify as an emergency?

I’ve heard of people using emergency funds for expenses that are clearly not emergencies. While everyone’s definition of an emergency is different, if you want to make the best use of your money, I would suggest not tapping money earmarked for emergencies for these expenses. That said, you can save separately for these expenses.

Vacation. It’s great to get away from your daily responsibilities for a time, but even if your therapist recommends an immediate vacation, you shouldn’t dip into the money set aside to cover emergencies.

A buying “opportunity” in the stock market or real estate. If you’re interested in timing the market or want to buy a house for the fun of it, save separately for the occasion. Most people overestimate their ability to time the market and could find themselves on the losing end of an investment at the moment they need the cash for a true emergency.

Out-of-town visitors. You just heard your friend from college would be in town for a weekend, and she’s suggested getting together for an evening out. If you don’t have extra cash flow at the moment, you might want to suggest a frugal option. Don’t feel you have to impress her by going to the fanciest restaurants and clubs, particularly if you have only your emergency fund available.

Mid-life crises. Recently divorced and quickly aging? It’s time to buy a convertible sports car. That seems to be the accepted path, but it can be a dangerous road to travel, particularly if your ex-wife has half or more of your money. Don’t dip into your emergency fund to buy a new sports car just because you want to feel young again. It may, however, be time to get together with an old college friend for an evening out.

Keeping up with the Joneses. The Joneses buy what they buy because they have no problem with debt. If you’re conscious about spending, you’ll never keep up with the Joneses in the accumulation marathon, nor should you feel the need. They’ve added a sun room and an in-ground swimming pool, but for all you know, they could be paying for it for years. Resist the temptation to match or exceed appearances, whether with debt or by tapping the emergency fund.

What do you think?

I’m sure there are many emergencies and an infinite number of non-emergencies I’ve neglected to mention. I will also bet the total of my emergency fund that some readers will disagree with some of my classifications. (Gambling: not an emergency; Paying your bookie: possibly an emergency.) Please share your thoughts.

Photo credits: au_tiger01, daveynin, and rayced

It’s been a long time since I’ve gone through my clothing and eliminated items which are no longer appropriate for wear. For most of my life so far, my habit of keeping clothes for a long time—until recently, I still had a few items left from high school (1994)—was out of necessity. I just didn’t have the money to replace clothing often. I decided, thanks to some encouraging from my girlfriend, that it was time to get rid of clothing I no longer wear either because I just don’t like them or because they no longer fit. Fortunately, my income supports the decision.

I was able to fill five bags full of clothing with mostly shirts that are now too tight or hopelessly out of style.

Rather than throw my unwanted garbs in the garbage, although lexically logical, I’d rather pass them along to someone or some organization that can make use of them or of the income that could be gained in exchange. I’ve seen bins by gas stations and malls labeled for unwanted clothing, but I am skeptical of these receptacles. To whom do you donate your used clothing? I’m willing to entertain any suggestions. I’m not trying to earn any money in exchange for my items, I just want them to eventually arrive in the hands of people who might need them.

While I ponder this and your suggestions, here are some personal finance articles you may enjoy. Read the rest of this article »

As I mentioned earlier, Consumer Reports makes it sound easy for the average family to find $500 a month in saved expenses. Scott Burns calls this the “power of attentive spending.” Pay attention to the little details and you can end the year with $6,000 more in your pocket than you would have otherwise.

The $6,000 in “found money” is tax-free. By reclaiming money you’ve earned but might have spent, you’ve basically increased your income without adding any extra tax expense. It’s not technically correct, but it’s an interesting way of looking at saving money. Think of what else you could do to increase your after-tax income by $6,000.

You could get a raise or a promotion, but usually these things have to be deserved. Working harder at your day job may inspire your boss to reward you with a bonus, raise, or promotion, but to make that $6,000 increase in your pocket, you may need a $10,000 increase in your paycheck. Scott Burns points out that a $6,000 increase represents six years of typical annual increases for the average employee.

It will be just as difficult for many people to generate that same additional annual $6,000 through investments.

Suppose, for instance, you have the good fortune to live in a no-income-tax state and want to get all your return from a portfolio of common stocks. At a 15% tax rate on dividends, you’d have to collect gross dividends of $7,059 to net $6,000 a year. With the S&P 500 Index yielding 2.29%, you’d need to have $308,246 in your portfolio.

You might fare better in interest-bearing savings accounts. In the 33% tax bracket, you would need to earn $8,955 before taxes in interest income. Earning an annual 3.5% which is possible right now in a few high-yield savings accounts, you would need a starting balance of $255,864 to end up with $6,000 in taxes. That would be an additional $255,864 above what you have saved now.

Looking at these numbers, finding possible savings within expenses looks like a good option.

Save $6,000 by paying attention, Scott Burns, MSN Money, August 13, 2008

I may have fallen back into old habits. Several years ago, when I was refreshing my life and beginning to control my finances, I made deep cuts into my expenses. I took on three roommates, paying only $325 a month for my portion of rent. I didn’t own a car and relied on mass transit for most of my transportation. When I did move out on my own, finding one of the least expensive apartments in town, I eliminated all but the most basic cable television.

There was more I could have done had I wanted to reduce my expenses, but I reached the point at which I was consistently investing and saving money every month.

As my income has grown over the past few years, I’ve allowed my expenses to follow. I moved into an apartment I actually like and feel comfortable spending some cash on unnecessary things I like, such as amateur coin collecting, amateur photography, and amateur high-definition entertainment enjoyment.

I’ve already thought of some ways to reduce my expenses by $10,000 a year. Consumer Reports has some suggestions for finding another $6,000 a year, but only a few apply to me. How about you?

Find cheaper auto insurance. I mentioned that several years ago I didn’t have a car. That wasn’t quite by choice; my license was suspended when I was younger for failure to pay speeding tickets. It would be easy to say that I received those tickets thanks to a stressful job working 100 hours a week and my failure to pay was because I had no money, but I should have been more responsible. Until I got rid of the car, my insurance was about $4,000 a year if I remember correctly. Now my insurance is about $1,500 a year, and I could only find that rate by shopping around for a while. It’s been several years since I’ve shopped around, so that’s something I will consider. I need to add renter’s insurance as well—something I’m sad to admit I’ve never had despite its reportedly low price.

Optimize your life insurance. Right now, my cat Rupert is the only living being that relies on my income to survive. I have not opted for life insurance yet as it will be generally unnecessary until I have a (human) family. According to Consumer Reports, insurance premiums have decreased on average, so it may be a good time to replace your policy with a new one. You may be able to get the same coverage for less.

Shop smart for food. Buying food for a single guy is not simple. Food is usually packaged for families. This means I usually end up spending more per meal and eating larger portions that I should be. I don’t enjoy spending time preparing and cooking dinner. I have accepted my failure at brown-bagging my lunch and moved on. Consumer Reports’ advice is tailored to a family, indicating on average an household could save $190 a month by shifting to less expensive food. My entire monthly grocery bill is about $190, though eating out (and ordering in) matches that.

Plan menus around sales on fresh poultry, fish, meat, dairy, and produce, and make use of leftovers. Avoid costly prepared meals. Eat more low-priced, high-nutrition foods such as beans and potatoes… Shop in lower-cost stores such as Aldi Foods, PriceRite, Costco, Trader Joe’s, Wal-Mart, and Sam’s Club, but be sure to compare prices. Try less-expensive store brands. Sign up for store discount cards. Stock up on sale-priced staples.

Stop paying bank fees. This is one of the most unnecessary expenses for just about everyone in the United States of America. There is rarely a reason that you should have to pay incidental or monthly fees for any basic banking service if you manage your money. Avoid overdraft fees or over-the-limit fees by being aware of your account balances. Avoid monthly or yearly maintenance fees by taking advantage of only free accounts—there are many to choose from if your bank insists on charging you a fee for your banking. Avoid cash withdrawal fees by using the right ATMs.

According to Consumer Reports, 52% of consumers don’t pay any bank fees, but the rest pay lots.

Optimize your telephone service. I don’t spend that much time on the phone. I could probably save a lot of money if I were to choose a prepaid cell phone plan. However, I chose a Blackberry plan with Verizon Wireless, which I use more for business, and I don’t intend on changing the plan.

I’ve helped other people look at their telephone usage habits and choosing a plan that better fits the amount of time they spend on the phone. On many plans, going over the allotted number of minutes can be very expensive. If you’re consistently exceeding your limit, you can save tons of money by switching plans.

Pay off your credit card. According to Consumerism Commentary, “On average, consumers who carry a balance owe $2,200, on which they pay 15.2 percent in annual interest charges.” Paying that much interest negates any progress you may be achieving with your savings or investments. To get rid of credit card debt, stop using the cards and then apply the Debt Avalanche.

It’s been several years since I’ve paid interest on a credit card, but I still pay about $30 a month on my student loan interest. I still have a student loan because several years ago, I applied some tuition reimbursement towards expenses rather than my loan. I probably should have done whatever possible to avoid that, but for whatever reason, it was the choice I made. At the time, the interest on the student loan was about 2% and I was earning more in my savings accounts, but that’s no longer the case. Therefore, I have been increasing my debt repayments every month this year, with the goal of vanquishing the remaining balance by the end of the year. If I decide that goal still makes sense, I’ll have to accelerate in order to achieve it.

According to Consumer Reports, the average family can save $500 by making the changes listed above. I have a feeling that many Consumerism Commentary readers are already optimized.

Cut your spending by $500 per month, Consumer Reports, August 2008 (subscription required)

Earlier today, I asked via Twitter how much everyone has in their emergency fund in relation to their monthly expenses. Here are some of the responses. (I assumed if the message wasn’t sent privately and if the twitter account wasn’t protected that I could re-post the source of the responses.)

• nodebtplan: 3 months of expenses in our emergency fund
• takingcharge: currently only enough to get me through a month or less, but working on saving enough for 3-6 months
• taliaishere: 3 months in the emergency fund, but am working towards 6 months-that would be much more comfortable
• Gblogger: Depends on what I count—we stopped segregating specific emergency funds a while back. But at least 6-10 mos.
• dreamscostmoney: 3-5. It used to be 3, but then I decreased my monthly expenses, so it’s probably closer to 4 or 5.
• BurgBarbL: I have about 1.5 months’ worth of expenses in my emergency fund.
• Private: In my emergency fund? One. Not great, I know. But with my new salary, I’m on a plan to make that three.
• SunFinancial: I don’t have a dedicated emergency fund. All are accumulated in one savings account.
• bargainr: 9 months

Among these responses, the average (while taking the low end of anyone who responded with a range) is about 3.5 months. Not bad! I have about 3 months’ worth of expenses in my account called “Emergency Fund,” but I have about an additional four times that amount across a variety of savings accounts.

If you’re interested in participated in occasional polls, follow me on Twitter. For those who don’t know, Twitter is a “social media” tool that allows you to broadcast and receive quick and short text updates. I promise not to send spam or to bombard you with “new post” updates. Mighty Bargain Hunter has a list of 118 personal finance bloggers who use Twitter, but many only provide automated “new post” notifications, duplicating an RSS feed.