Archive for the 'Budgeting' Category
Monday, January 26th, 2009
For the past several months, we’ve been using a crude but effective way of tracking our overall spending each month. The basic idea is that we only put the amount of money we actually want to spend into our primary checking account, and then pay all our bills out of that account. Everything else goes directly into either a high-yield savings account, an IRA/401k/403b, or a brokerage account.
Add in an appropriate buffer balance to avoid overdraft fees, and ideally our bank balances should look something like the sinusoidal line below:
So what is a proper spending goal? I would recommend looking at your current spending levels first, and then deciding on a numerical goal of say $X,XXX per month.
Or, for us, we decided that we wanted to live on only one of our incomes (the lesser one). So only that paycheck is direct deposited into our “spending” account, minus retirement account contributions. We pretend this account is all we have, carefully watching that the balance does not go below the buffer level. (We are signed up for e-mail alerts if we do hit that barrier.)
In addition, we note the high and lowest balances for the last 30 days. This helps keep a rough trend that we are headed in the right direction. Here is an graph made from the actual daily balances of our checking account from the last few months:
The biggest benefit is that because it is so simple, we actually do it! By keeping all our other transactions separate, it really helps us pretend that we only have a certain income. It’s a reflex that when I see the balance get low, I get nervous and start changing my spending behavior. If we eat into the buffer one month, then the next month we have to dig our way back.
Also, looking at the big picture in this way prevents the cheating that sometimes happens when we have a large unexpected expense like a plane ticket to visit sick family or a surprise car repair. It’s so easy to ignore that chunk and say that we still did okay our regular categories like “Gas” and “Groceries”. And we all have unexpected expenses, right?
This system really works best for those that already have a basic idea of what they spend each month, and aren’t looking for drastic changes. It does not provide any deep analysis, such as identifying areas to cut back. We’ll have to do that separately, or use another budgeting system.
Thursday, November 13th, 2008
I just filled up my tank for the least amount of money in a long time. When I first wrote about hedging against rising oil costs, the national average was $3.70/gal and headed towards $4/gal. Now it’s around $2.15. Remember when we were all afraid of $5 gas? Which got me thinking, perhaps now is a good time to reconsider hedging gas prices?
Example scenario: If you drive 12,000 miles per year and your car gets 25 MPG, that means an annual fuel bill of $1,920 with $4 gas. But with $2 gas, your annual bill is now only $960. Makes sense, a doubling of price from $2 to $4 again will lead to a doubling of cost – nearly $1,000 per year.
Now let’s say you buy $1,000 of one of the two major oil ETFs tracking crude oil prices, USO or OIL. (Use a broker with free trades.) If crude oil prices jump again, then the value of these stocks should roughly rise to compensate. If $4/gal comes back, your annual fuel bill would rise by $1,000, but your oil futures stock should also rise by $1,000. You’re virtually fully hedged this way, even if gas goes to $6/gal or higher.
So I suppose being fully hedged means buying as much oil ETF annually as you spend on gasoline in that time. Effectively, you are buying a year’s worth gasoline ahead of time and locking in that price. If gasoline wasn’t so difficult to store for long periods, you could do this manually.
Now, there is no free lunch here. If gas prices drop even further, then you won’t be able to benefit from cheaper gas either. A drop to $1 gas would leave you missing a savings of $500 per year, although I have a hard time seeing it drop that far.
Cost of hedging. Don’t forget, you could have invested that $1,000 somewhere else. If you assume an annual return of 8%, that’s a missed opportunity cost of $80 per year. Of course, we all know now that assuming stable 8% returns is not good. If it would have been held in a bank instead (a more likely scenario), then a 3.5% APY leads to an annual cost of $35, or $3/month.
Hedging is about having a price that you are comfortable paying, so that you don’t have to worry about unexpected price swings. Usually, it is also the case that you are more afraid of a potential rise than a potential drop. Gas prices have been one of the more volatile parts of our budget, and we could use this period of lower prices to build your hedge. Is it worth paying $3/month for such a hedge? I’ll let you decide.
Tuesday, October 14th, 2008
Quicken Online is now free. It used to cost $3 per month ($36/year). This established brand name is now directly competing with other free online account aggregation services like Mint, Geezeo, Wesabe, and Yodlee MoneyCenter. I guess they decided it would be better to give this product away for free as well, in the hopes that they can sell you TurboTax or the desktop Quicken later on. I signed up; here is a screenshot:
Although I keep meaning to do a more in-depth review of all these services, I have not done so yet because after trying each of these services briefly I always end up going back to my trusted Yodlee MoneyCenter. I have been disappointed in how they all (including Yodlee) unsuccessfully attempt to categorize my purchases, and I am unwilling to keep manually correcting them.
I prefer the simple “snapshot” feel of Yodlee, where I can see all my balances and investments at a glance, along with recent transactions. I can even keep track of my frequent flier miles and other rewards points. Each day I log in, acknowledge any changes, and am done within 5 minutes. “Get in, get out, get on with your life”.
Other more personal (and lame) reasons include sheer habit, as I have been using Yodlee since 2004. Finally, I have a lot of accounts, and the idea of having to re-enter all those passwords again is not appealing at all.
All of these sites take your logins and passwords, and essentially pretend to be you and scrape the pertinent information off each webpage using a script. Yodlee actually sells its account aggregation services to Mint. Geezeo uses CashEdge. Quicken Online and Wesabe have their own systems. Be aware that in many cases you are giving them limited power of attorney to do this. It’s all in the terms and conditions! Many people wisely are very skeptical of handing over all their passwords to a third party. I have previously posted a modest defense of my use of Yodlee here.
Wednesday, July 16th, 2008
I understand that revealing our net worth is not enough to fully explain our entire financial picture. That is by design; I like keeping the picture fuzzy. Blogs are very hard to keep anonymous, and I’ve been doing this since 2004. This is why I continue not to share our respective salaries, occupations, employers, and geographical location. Besides, I am not here to be better than you, or the next dude. Anyone out there could earn more than me, save more than me, or spend less than me. I’m only trying to track our progress, and to consistently try to make our situation a little bit better each day.
But I’ll give in a little bit. I think tracking expenditures is a good idea for everyone, so I might as well share what I have discovered. Besides, I’ve already revealed that our goal for an Emergency Fund is 6 months of expenses, or $30,000. That means my wife and I spend $5,000 a month? How? Here’s the lovely pie chart:
Housing: We spend $3,500 a month housing, 70% of our total monthly expenses. (Note that this is not the same as 70% of income!) This includes principal, interest, taxes, and insurance (PITI). Yes, it is obscenely high. The median price of a home in our area is over $500,000, so don’t go thinking we live in a multi-acre 5,000 square foot estate. At the same time, incomes here are also a lot higher, especially in certain fields. So there is a give and take.
Given that this one area skews the graph so much, I made another graph of all non-housing expenses:
Food: $450/month includes both groceries and dining out. This is where the “fat” is in our spending, and we know it. We love food and do our best to “consciously spend” and enjoy every dollar put into this pleasure. I’m okay with making many simple foods at home, but I still go out when I want to eat freshly baked naan, perfectly seasoned pad thai, authentic pizza, or hand-wrapped tamales.
Insurance: $200/month includes two cars and umbrella liability insurance policies. Our deductibles are $1,000 to keep costs low, but our liability limits are high ($250,000/$500,000) due to the requirements of the umbrella policy.
Utilities: $200/month includes electric, gas, sewer, and water. Gasoline: $200/month. Cable TV + Internet: $80/month. Cell Phones: $75/month for two lines.
Gifts: $100/month. This might be somewhat unique to us, but given our big family events like birthdays, weddings, graduations, usually end up costing us $100 per month.
Other: $200/month usually covers the other smaller categories including clothing, entertainment, and pet expenses.
That ends up with the total being $5,005 per month. $3,500 to housing, $1,505 to everything else. Health insurance is provided by our employers. Non-monthly expenses like home improvement projects, travel, charity, car purchases/depreciation, or medical procedures are not included.
Sunday, June 15th, 2008
Kaizen is a a Japanese philosophy that focuses on continuous, gradual improvements in all areas of life. A popular example is that of Toyota Motors, where any worker can stop the entire factory line if they see an abnormality and worker suggestions are welcomed and regularly implemented. The role of kaizen in Toyota’s success is discussed in detail within this New Yorker article “Open Secret of Success“:
…Toyota’s approach: defining innovation as an incremental process, in which the goal is not to make huge, sudden leaps but, rather, to make things better on a daily basis. [...] Most of these ideas are small—making parts on a shelf easier to reach, say—and not all of them work. But cumulatively, every day, Toyota knows a little more, and does things a little better, than it did the day before.
The parallels to personal finance are relatively obvious but I think it is still easy to underestimate the power of such small, continuous, improvements.
Starting a New Business
Many of us may have ideas about starting up a new business (side or full-time), or even consider a career change. But the task can be daunting, so we put it off. But taking small steps towards such a goal are relatively easy. Spend a little time regularly making contacts, read and learn new skills while sitting at a cafe, or simply making your fuzzy daydreams a little sharper. It doesn’t even have to be daily.
Changing Your Spending Habits
Habits are by definition almost subconscious behaviors, and very hard to break. This New York Times article “Can You Become a Creature of New Habits?” explores why using kaizen instead may be better suited to changing our habits as opposed to other more aggressive methods:
“Whenever we initiate change, even a positive one, we activate fear in our emotional brain,” Ms. Ryan notes in her book. “If the fear is big enough, the fight-or-flight response will go off and we’ll run from what we’re trying to do. The small steps in kaizen don’t set off fight or flight, but rather keep us in the thinking brain, where we have access to our creativity and playfulness.”
If you want to start a budget, why not tracking your spending in just one category, like dining out?
Taking it another step further, instead of just saying “I need to eat out less”, why not ask why you order out so much. For us, often times it is simply because we are tired and there is nothing easy to cook in the fridge. So I have started to keep a better stocked pantry and also make a regular schedule where I buy a small amount of “standard” fresh vegetables which are easy to incorporate. Each time I find a good recipe that uses only what is in my pantry, I write it down, so I slowly accumulate our own custom lazy-proof cookbook.
Kaizen Is All About You
These are just a few examples, and is kind of how I like to think of this blog. There are so many complex topics that are impossible to learn all at once, from investing to insurance to taxes. Every day I read and skim a lot of information, in the hopes of gleaming something a little useful that can help me get a little closer to leaving the rat race. It may just seem like little nothings, but when you add it all up together I know it has made a huge difference in our financial lives. But what may strike a chord in me might not apply to others, so it’s all about taking what works for you and applying it.
So remember, as long as you learn or implement something a little new each day, you should be happy!
Monday, April 21st, 2008
Most of you are reading this right now because you want that elusive “financial freedom”. This usually revolves around net worth, and many of us (ahem) have a specific net worth goal they want to achieve. Various formulas and calculators abound. The popular book The Millionaire Next Door suggests this formula for a target net worth:
In addition, there are various debates on how to measure net worth. Do you include your primary residence, or not? What about cars or jewelry? How do you properly account for pre-tax accounts? However, while reading this post at Early Retirement Extreme amongst others I realized that these are not the things I need to be focused upon.
Financial Freedom Ratio
If someone tells you that they have a net worth of $1,000,000, you might be impressed. But what if they spent $150,000 per year? If they stopped working, the money wouldn’t last very long. However, if they only spent $15,000 per year, they might already be set for life. In other words, your income doesn’t matter. Your expenses do. It may be assumed that the two are related, but that is not necessarily true. We all have the power to disconnect the two.
I’m sure somebody somewhere has already coined this term, but until told otherwise I will call it the Financial Freedom Ratio (FFR):
By liquid, I simply mean you can sell it for cash while not affecting your expenses. (Don’t count your car if you need it for work.) For example, if you had $200,000 but only spent $20,000 per year you would have the FFR value of 10 as someone with $1,000,000 but spent $100,000 per year. This also calls into focus how important spending patterns are when talking about financial freedom. Let’s say you had the 200,000 net worth and you wanted to increase your FFR from 10 to 11. You could either
- increase your liquid net worth by $20,000 and spend the same,
- decrease your annual spending by $1,820 and not earn any more money,
- or some combination of spending less and accumulating more.
Sure, it can be very difficult to keep slashing expenses, but this ratio keeps you honest as to how close you are to financial independence.
What Is A Good Financial Freedom Ratio?
To find this, I went to the Vanguard Annuity website and looked up a price quote for their inflation-adjusted fixed immediate annuity (Lifetime income option, fixed payment, bottom right). This means that, if I give Vanguard a lump sum of money, they will give me a regular income that is adjusted every year for inflation per the CPI-U. (Annuities are subject to the claims-paying ability of the issuing insurance company, which is AIG Insurance.)
I input that I was 30 years old and wanted an inflation-adjusted $30,000 a year ($2,500 a month) for the rest of my life. The quote was $857,000. So a lifetime of my required income requires an FFR of 28.6 ($857,000/$30,000). As you get older, the number decreases.
Using the popular but controversial 4% safe-withdrawal-rate rule for a balanced stock/bond portfolio, you would need a FFR of 25 to have a good chance of living off of your investments without having to annuitize. Keep in mind the 4% value is not adjusted for inflation, so your buying power would decrease each year.
What’s My FFR?
I’m not sure exactly how much I spend per year. I need to fix this. I should be able to back out the numbers for 2007 pretty easily since I track our net worth and I just did my taxes, but I’d need to cancel out things like unrealized investment gains. Roughly, I would say that last year we spent somewhere between $25,000 to $30,000. This year, it will be much higher due to housing expenses, although one day the house will be paid off. My FFR is certainly less than 10 right now, more like in the 8 range. Single-digits!
Track Your Expenses
I like the FFR because it gives me a better idea of how close we really are to financial freedom. In addition, it reminds me that our expenses matter equally as much as our net worth. Do you know how much you spent last year? I am convinced that spending is a habit. If you spend modestly now, it will be easy to maintain this in the future. If you spend lavishly now, it will be very difficult to downgrade later on. We all have our luxuries which we hold dear, I know I certainly do, but it has to be weighed against how long you want to keep working and saving.
So, after all this I suppose I need to figure out how to gradually shift to a simpler and less costly lifestyle. Heck, forget cutting expenses, I spend a lot of effort simply trying not to accumulate more expenses these days…
Thursday, April 3rd, 2008
You may be expecting a review of the new online service SmartyPig. Well, that review is in-progress, but while doing my research I was reminded of an alternate way to create your own online “piggy bank”. Remember how you’d actually have to save your quarters to buy what you wanted? Oh, the good old days…
Let’s say you want to set up multiple “baskets” or “piggy banks” of money for specific goals. Maybe you have
- an ongoing pet medical fund to which you add to regularly instead of paying for insurance ($50 per month?)
- an ongoing car maintenance/repair fund (I need one of these)
- a summer vacation fund (goal: $1,000?)
- a Christmas fund
- …or that all-purpose emergency fund!
You want separate balances and accounting for each account to keep things neat, but you don’t want to open up 3 new accounts at 3 different banks. The good news is that this can all be done with Capital One 360 – they let you easily and instantly create multiple savings accounts that have their own balance and nickname. No credit checks, no applications, and it earns interest. Here’s how:
1) First, you’ll need a Capital One 360 account. If you have one already, you’re all set. If you opened one before and it got closed to due low balance or inactivity, you can have them re-open it by calling 1-888-ING-0727 (or you can login and do it). If you are a new customer, you can earn a $25 sign-up bonus here by opening with at least $250.
2) Open up an additional savings account (or several!). It’s not all that complicated, but it still confused me initially so I broke down the steps below with screen-by-screen walkthrough. Click on the thumbnail images for a full size screenshots.
3) Set up an automatic savings plan
Although you can schedule manual transfers, why not make it easy on yourself and set up an automated transfer schedule? You can set a fixed amount of automatic withdrawals if you have a specific goal ($100/month x 1 year = $1,200 = HDTV), or you can make it repeat indefinitely (great for our often-used pet fund).
And you’re done! You can make as many of these sub-account as you like. The cool thing is you can make withdrawals at any time (max 6 per month), and there are no minimum balances or fees. The interest rate at 0.75% APY isn’t the absolute highest, but comparatively it’s no longer that far behind other similar banks.
(FYI – I was talking with my sister about this and she told me she didn’t use her Capital One 360 account anymore. When I asked why, she said it was not because the interest rate wasn’t high enough, it was simply because they made you log in with your customer number, and she would never remember it! I just wanted to point out that now you can pick your own username (like “janedoe444″). Use it carefully though, as your password is still just a 4-digit PIN.)
Tuesday, March 11th, 2008
Last month one of our credit card statements spanned two pages because we had eaten out so often. Not only is it more expensive, I’m pretty sure it’s less healthy. So now we’re trying to limit ourselves to 2-3 times a week (minus the cafeteria at work), and making one of our outings to a new restaurant that we haven’t tried before.
This means more grocery shopping. But did you know that grocery food prices jumped 5.3% in 2007? Milk, eggs, and bread all cost from 10-30% more than last year. This year looks to be even worse, especially with rising oil prices making transportation more expensive. In last weekend’s WSJ Sunday edition, there was an article titled Savvy Grocery Shopping that had some good money-saving tips. Here are a few of them along with some others I’ve also picked up elsewhere.
Stockpile and Hoard
Grocery stores constantly rotate the stuff that they have on sale, so that at any one time there is something new to attract you into their store. Then, while you’re already there, they expect you to buy other things at full price. The key is to know when something is at a great price, and then stockpile staples at that price. That way all your pasta, canned veggies, soups, broths, sugar, and all non-perishables are all bought 20-50% off retail.
Keep Track of Prices
The problem: How do you know what is a good price? I forget all the time. Some people keep what is called a “price book”, where you track the price of your commonly bought items so you can start to see the cycles and pricing patterns. There is even a website called TheGroceryGame that will track prices for you and let you know when to buy – for $10 every 8 weeks.
I’ve also noticed that you can also start to learn when they mark down meat, usually a day or so before the legal sell-by date. The meat is still good, I just stick it in the freezer right away until I need it.
Be a Coupon Ninja
There is an entire subculture of “couponers” out there that I call “coupon ninjas”. They find good coupons, then get 20 duplicates of them, go to a store that doubles them (instead of 25 cents off you’d get 50 cents off) and then stockpile like crazy. I’ve seen scans of grocery receipts that show $150 of food bought for $23.47. Sometimes they actually get negative! While I admire their drive, I just stink at using coupons. I’ll clip them, but I always forget to bring them along, or I wait until they are expired. My new store doesn’t double coupons anymore, so the incentive is also less. TheGroceryGame also helps point out good deals.
Buy Frozen and/or Generic
Many times frozen fruits and vegetables are even more nutritious or tasty when you buy them frozen, because they can wait longer before picking them. Also, there’s always store-brand or generics. The article shares that the manufacturer of Birds’ Eye veggies also makes store-label veggies. I love my Safeway frozen mixed vegetables! Did you know that produce even has brands now? I didn’t even notice. I like to buy generic on many things, but not all of them.
Thursday, November 29th, 2007
Since the Sunrocket demise in July, we have been living with just a cell phone – no landline or VoIP – and it’s actually worked out pretty well. I like the simplicity. We haven’t had any overage problems, but I did tend to check a lot in the beginning to make sure. Here are some easy ways to to check your remaining minutes for several cell phone providers:
Dial *MIN# (*646#)
AT&T Firefox plugin (might currently be broken)
Dial #MIN (#646)
Verizon Firefox plugin
Dial #MIN# (#646#) or dial 611 + say “minutes”
T-Mobile Firefox plugin
Dial *4 or dial *2 + say “minutes used”
Sprint Firefox plugin (not currently working for me)
Then there is the Windows desktop application WatchMyCell, which logs into your online account page for you and tracks how many minutes you have left. It will even send you an text message or e-mail whenever you’ve reached your chosen threshold.
Now, all of these automatic methods will require your username and password. Although I’ve done some digging and found nothing obvious, I can’t be sure none of them are doing anything shady. I would at least change your password to something unique to the site. Personally, I just program the number as a contact. Let me know if I missed anything.
Friday, November 9th, 2007
Heard on the radio yesterday: “Hey people, there’s only 3 paychecks left until Christmas!”
The Holidays are coming! Black Friday ads are already being leaked. The new mantra is “Why not just buy it now?” You hear a lot of scolding about all the consumerism in response, but the malls always end up packed no matter way. Perhaps the best way to deal with this annual event is to simply budget for it? It’s not like these are surprise expenses – should it really matter how many paychecks are left?
The other day I was reading about a tiny credit union that my wife’s company partners with, and they offered a “Christmas account”. It’s just an extra savings account where you can put in regular deposits each month. My cynical side thought “How quaint… like anyone does that anymore.” Kind of like how layaway no longer exists.
Or does it? Here’s a poll exploring how people deal with the expected expenses of the winter holidays. Decorations, travel, food, gifts…
Saturday, September 1st, 2007
You and your significant other love each other. Still, I bet there is still something that one of you loves spending money on that the other simply doesn’t see any value in. It might be manicures, gadgets, designer clothes, online poker, or Star Wars collectibles. If you have joint finances like we do, this can cause some resentment. Why is our money being spent on Yoda PEZ dispensers??
One possible solution to relieve such stress that we are currently trying out is the Adult Allowance, where each person is given a certain amount of money that they can spend with no questions asked. I’ve seen it in a few places, including Him and Her over at Make Love Not Debt. No rolling your eyes, no passive-aggressive sighs, no exasperated “Why would anyone buy that?”. Actually, one annoying question from me is “Why didn’t you let me spend 10 minutes researching the best deal for your XXX purchase?” The idea of paying more than needed may cause me physical pain, but why should I let that ruin her purchase?
Yes, this is essentially budgeting, but many couples view budgets as tedious and restrictive. I see this as a specific subset of budgeting which focuses not just on the ability to track spending, but the freedom of enjoying your spending without guilt. This may be a good place to start if one of you is spender, while the other is a saver.
On a technical level, some people use cash in envelopes, while other use completely private and separate bank accounts. That way, after you run out of money there’s no going back for more. However, we’re keeping it simple and just tracking it on the honor system.
We mentioned this to some of our friends, and some of the responses were the expected “An allowance? Whoa, that’s harsh.” But one of the couples actually implemented it for themselves as well! It turns out that the guy was getting some flack for driving around his gas-guzzling 4WD beast around instead of the econo-box they also own. Now, he’s been given a monthly gas budget each month so he can still have fun, while she can feel that the gas bill is under control.
What do you think about adult allowances? Good idea for resolving potential conflicts? Or unnecessary for those in a good relationship?
Saturday, April 28th, 2007
I’ve been trying to find a pie chart listing the spending breakdown of the average American to provide a frame of reference for our spending pie chart last year, and here is the closest I could find. It’s in terms of pre-tax numbers, and I added the percentages for clarification:
The chart was taken from an article by the Tax Foundation think tank, whose stated mission is to “educate taxpayers about sound tax policy and the size of the tax burden borne by Americans at all levels of government.” However, there is some argument about the accuracy of these numbers.
Note that there is no slice for Savings, as our savings rate is negative according to their calculations.