Emergency Fund - true emergency or investment money?

People say you should have 3-6 months in cash in an account in case of emergency. But what if you decide to invest this money instead and only pull it in time of dire emergency? Say emergency surgery, death, or job loss? What is the likelyhood that you would ever need to touch this money? Low? High?

If that were the case would it be wiser to invest this lump sum of money? For us the 6 month EF would probably be around $30k, which is no chump change. Thus I've decided to invest our EF. For a few reasons, the least of which is it's too much cash to just be sitting there.

One good compromise is that we save quite a bit into an ESPP so if we should need it we could cash in some stock. Another reason to invest, is that I don't consider my EF a catch all account for emergencies. I believe that our EF is only to be used in dire circumstances. All other expenses should be saved for in advance or something in our budget must be cut to accomadate the new need. This is not a permenant change necessarily but a temporary one.

So I would do everything in my power to cash flow any expenses and keep a large enough pot of money that I wouldn't have to pull it out of my EF. What do most people do? Do they keep their EF liquid in a savings account or CD? And under what circumstances would they use their EF?

Reconciling different investment tolerance

I'm not sure how this came up, but last night DH and I were discussing our different levels of tolerance for risk in our investments. I know I'm definitely on the high end of risk for investing, I'll do 85-90% stock mutual funds and 10% bonds. I also lean more conservatively however to index funds.

However last night I find out DH thinks he can always beat the market and that his risk tolerance is extremely high. How high? Well he thinks at every level of risk there are oppportunities to be made. This means we should have a diversified portfolio of individual stocks and actively managed mutual funds. He doesn't believe that index mutual funds are enough. He thinks we should ebb and move with trends and try to time the market. He's a very logical guy and extremely smart. Yet I'm not sure where he's coming from, and having difficulty reconciling the idea in my brain.

I guess my issue is that I'm okay with playing with individual stocks, but to me that money is free money. It doesn't matter if it goes away or not. To him, it's all money and if a stock goes broke then the mutual fund will also go broke. This doesn't sound feasible to me and yet I can't argue with him because yes a mutual could lose 50%. And yes a stock can make 500%.

I guess I wonder what do most people do with their spouses? How do you reconcile your different tolerance levels for investing? Does one person handle it all? Do you agree on the more conservative investments to make the conservative person happy? Do you split it in half? How do you build a portfolio with different ideas?

Carnival of Personal Finance #76

This week my article about my best and worse money moves was posted at the Carnival of Personal Finance #76. It looks to be a great week. Here's my post My Best and Worse Money Moves.

Black Friday Shopping

I haven't yet decided if Black Friday is worth it. I went out pretty early to get a few things when stored opened. They were mostly practical items I had been waiting for to go on sale and usually don't. So it wasn't a big deal. I really wanted a laptop computer, but the line for that started Thanksgiving day, so I figured I wasn't that crazy to need to sit there to save $400.

I wonder if people really realize the opportunity cost of them sitting there for these purchases. Are they things they were planning on buying anyway, or just stuff they had to have to fufill their stuffitis needs? Do they earn enough to afford the regular price, but are super thrifty and are willing to sit and wait for the absolute best deal? And how to weigh that against spending time with their families.

We bought some SD memory, speakers for the computer, a steam vacuum cleaner, sheets, and gloves. All in all, things we were going to buy, but we willing to wait on to get some pretty nice deals. The inner cheapskate in me was crying out to sit there and wait for the $250 laptop, but the inner realist said you have to go and hang out with your DH.

What did you buy for Black Friday if anything?

My Best and Worse Money Moves

I'm chiming in because Nickel started this on 5 cent nickel. I'll probably be the only person who will write about their best and worse money move being the same thing. But

My Worse Money Move:

Buying a home with DH back in 2002. Sure we made a lot of money on it, and it was a great investment, but the truth is there were a lot of unknown risks I certainly didn't imagine. First we weren't married, or engaged really (we knew but hadn't done much), we decided impulsively "let's buy a home together we're tired of moving." Well we didn't write up a contract, we didn't figure out how much each of us put in, and we didn't discuss what might happen if we broke up.
Um, yeah, now 4 years later I realize the stupidity looking back.

Actually I pretty much realized it immediately, when people stared and gaped at me when I mentioned buying a home with my at the time boyfriend. Did I mention I got numerous people tell me their horror stories about having to sell a home or move out after they bought and broke up with their significant other. It seems everyone does something this stupid at least once in their life.

Did I mention I compounded the stupidity by going solo on the mortgage application because DH was on a Visa? And that I quick claim deeded the house to us jointly? He could have walked off without any debt and half a home. Sigh, definitely not exactly my smartest moment.

After I realized this 4 years ago, I decided if it didn't work out then it was just a huge tuition payment to Life University (aka stupid tax).

Best Money Move:

Well buying the condo was the best thing that happened to us as well. We rode a huge appreciation wave and sold the condo for about twice what we bought it for. We had considered that perhaps we were buying at the peak, but decided the risk was worth having a place we never had to move again. Our investment not only benefitted us financially, we also had less stress from not worrying about moving again. Also we were able to get a dog, actually the reason we bought because we wanted to get a dog together. And here's the kicker we finally said we were getting married before we bought. We knew we were in it for the long haul, but we said this is instead of getting married. And yes we could have gone down to city hall, but we didn't, instead we just called this our early wedding present to ourselves.

So my best/worse money move was all rolled into 1 thing. Now when people talk about buying a home together, I warn them of the dangers involved in buying something when you are not legalled wed. Of course this probably would have been told to me if we had bothered to tell anyone instead of hiding the fact. Yes we knew our parents would disapprove, so we decided not to mention it to anyone until we closed on the condo.

Would I change it if I could go back in time? No way! I adore my DH and our life, but if my kid every does something this stupid, I'll reach through the phone and strangle them.

How to sell a stock?

I had this conversation with a coworker, who actually wrote into Money Magazine and was published. When do you sell a stock? The price could be hovering at an all time low or the lowest of the year. It could be beaten down into submission with analysts saying what a great buy. Thus buying a stock seems substantially easier than selling, because greed sets in.

Do you set a sale price and stick with it? And if you do, what happens if it goes up another 205 do you cry over missing the growth? Or do you sell when you see the momentum slipping and the stock dropping? And hope you've already made a tidy profit to ride out the drop. Do you buy for the long term or ride short term bubbles?

How do you know when you are satisfied with the money you've made with a stock? Currently we're still sitting on the company ESPP and it's made a 50% increase since the purchase price. It appears to still be going up and we are not yet sure we should sell. It's greed talking, fear of missing the high. It's also faith that what we're doing is good and everyone is acknowledging it, so the price should go up.

But when do we tally our wins and losses and run?

Flipping our Wii

Okay so we went and got a couple of Wii this weekend, mainly because we really wanted one. But then we decided we put an ad on Craigslist and try to sell it. Well before we could respond we ended up selling the Wii's for a tidy profit and not having any to play with. This is driving my DH crazy.

I had only agreed to wait in line at Toys R Us for an hour before midnight opening. Turns out it was enough for a Wii (we were 140 out of 175) that got a Wii. The moment we returned home at around 2 am (there were four cashiers working really slowly) and they were letting 10 people in at a time, we decided hey let's post it for sale on Craigslist. When we awoke we had sold both Wii for $175 profit. So my DH decides let go get another couple Wii at Costco, which again turns out we waited for an hour before opening and both got Wii. And again when we get home we decide to flip the Wii. And again we sold our Wii on craigslist.

So in the end we made enough to justify buying a Wii, though we had entered this just hoping to score one. We didn't actually expect it to be so easy. The only issue is listening to my DH complain about not having his Wii and really wanting one. For those of you who know us, you know we've already got our gamecube hooked up and we play it quite regularly, so this is not as impulsive a purchase as it would seem. Unfortunately DH may have to wait now until after Christmas to play Zelda.

Now if only I had gotten my hands on a PS3.

Carnival of Personal Finance #75

I entered my first ever personal finance carnival. This is a weekly write up by people who run blogs about personal finance. There are many entries and a wide variety of flavors for people to enjoy.

I'm linking back to it now. It's being hosted by Hazzard at Everybody Loves Your Money...

http://www.everybodylovesyourmoney.com

Buying a Wii or PS3

People have gone literally crazy this weekend buying a Wii or PS3. They have been waiting for a week for the PS3. One man was shot and robbed in Connecticut for his PS3. One may ran into a pole while they stampeded into Walmart to grab the PS3 off the shelves.

Of course the PS3 have been selling for on average $3000, however it had been sold for as high for $6000. Is it really worth dying over? Obviously people think so. The PS3 is retailing at $600 but the Wii is retailing at $250.

My DH and I have been dying to get a Wii, and we stood in line at Costco this morning. We actually got one without too much wait time, about 1.5 hours, and we got to sit in the car and wait because we got a ticket. Actually we bought two and we're in the process of selling one of the systems. We actually might flip both systems but we're not sure.

Now I guess comes the time to decide how much do people want to spend on a Wii because they won't be able to get a PS3. PS are supposed to have shipped only 180k out, the Wii will try to get out 6 million out by March 2007. Does this mean it's a saturated market or will we be able to sell the extra console?

How to split the bill when dining out?

Tomorrow we're going out with DH's old boss and I'm feeling a bit nervous about how to pay for the meal. This is our first meal out with them, we only went to their home once (big celebration) and we never socialized with them before. Should we pay? Do we split the bill?

How do most people typically split the bill when they go out? I hate this scenario because there are so many different situations. We'll start with friends, typically we divvy it up our share and throw in money. Often times someone throws in extra, but no big deal. Or we sometimes ask for separate checks. I guess also depending the person, sometimes we just go back and forth, it seems to happen with our two best friends the most.

But how do you split a bill with coworkers? I've found that a lot of them like to just split the check equally which is difficult for me because I don't drink when out with others I work with. This means typically my share of the bill is substantially less than others, and I'm always bothered that I'm paying for someone else's beer. Sometimes I'll get a separte check and say I'm paying by credit cards. Or other times I'll just drop in enough cash to cover my meal + tip/tax. Is this wrong?

Finally I guess is family, do you pick up the bill or split it? I've found that we pick up the bill depending on the family member. We've started making "real" money so we've started paying for our parents. And unfortunately other family members are starting to expect the same as well. I find this a bit difficult because it's the two of us, but my sibs and their kids, so the balance is a bit disproportionate. Also I feel we're expected to treat because we make "good" money and have little responsiblities, which is true, but I'd love to save a bit more instead of blowing a lot on a dinner out.

Well since we're out to lunch tomorrow if I have a chance I'll try and update on the splitting the tab situation.

Do you need a spending plan?

The more I read, the more I wonder if people who are savers by nature have trouble spending money? I find myself occasionally questioning how I spend money. And yet why do people who save have such trouble spending money on buying a new couch, new car, or going on vacation they saved for and have already set aside cash?

Is it the fear of the future? Fear of needing the money? Or is it feeling that they are unworthy of enjoying the fruits of their labors? I think that it's admirable to be saving for retirement, paying off the mortgage early, college for your children, but is there a point where you are not enjoying your life as much as you should? Do you scrimp and not take hot showers? Or not use the dishwasher or dryer because of cost? Do you only shop with coupons or not buy meat because you watch your grocery bill?

Growing up I never realized how unfrugal my parents were. I thought they were the cheapest people ever. But now looking back I realize they prioritized for what was really important to them. Yes driving the same car, watching what we spent on clothes, saving for retirement, not buying a super fancy home they lived modestly. But my mom never scrimped on food, at the grocery store I always got fresh sashimi ($19.99/lb every night I got some), fresh juice, whatever meat I wanted, fresh veggies, any snacks, and pretty much anything. We also spent on music lessons, swimming lessons, etc, school/education related items. My parents would pretty send me on every opportunity the school had including trips to Washington DC from Hawaii for spring break.

So my mom cut in places that seemed important at the time, fancy car, bigger home, fancier vacations, yet she spent where she felt it most important, her family. Our health and well-being were the top priority. My mom has also always had a christmas savings account and has no trouble spending it, but I talk with people who are having trouble buying a couch or a car with money saved.

I find myself right now wondering which path am I going down? Is the path to living a thrifty life unable to spend forever? Or will I do need a spending plan? And would I change my spending habits if I knew I only had 10 years to live? My aunt and uncle, wonderful thrifty people, now live their life like there is no tomorrow. About 3 years ago my aunt went into a multiple sclerosis induced coma and was hopsitalized for 6 months. Because of that, they now travel, eat out every meal, and enjoy their time together without looking at the bills. Their time together is short and my uncle tells me, all the saving we did from our 20s has to be spent now because if "your aunt" dies then what will be the point to spending it alone?

I guess that's the problem with getting caught up in the savings mentality. We mute our desire for spending of any sort at what price? How do you strike a balance between saving and spending?

Breeding Costco Loyalty...

DH's had this argument with many a friend, either you love or you hate Costco. You either kneel at the alter and worship the deals, or you think paying for membership to buy things in bulk a huge joke. There doesn't seem to many people in-between. But how does Costco build such brand loyalty? How do they manage to make people who high incomes loyal and devoted? It's a very strange phenomena, and we're only a young married couple without kids and we're already brainwashed into thinking it's a great deal...

I've come to a few conclusions, Costco forces companies to give them a cut rate deal on the items for sale. They only choose items that the consumer wants and tailors each store to the desires of the community it's in. However Costco keep the exact same layout for each store, so if you happen to wander into another store, you still feel at home. This is true whether your on the East or West Coast, or Canada. To give an example, in Canada they sell fries with curd and gravy, but in the states they sell hot dogs and chicken bakes. Absolutely brilliant. How many stores do you know cater to their neighborhood? Most big box stores just do the same thing everywhere and figure that everyone pretty much wants the same. Not true, it really draws you in when they tailor the products to thing you like

Second, the gas deals. That's what really got us hooked on Costco, was in San Diego the gas was 10-15 cents cheaper per gallon than anywhere else. So we we made our weekly trip to costco to fill up, and stopped in the store just to shop. Sure there is the $45/fee, which seems to deter a few people, but if you calculate you drive 10 gallons/week or 520 gallons a year, and you save 10 cents a gallon, then you've saved $52/year in gas alone. So there's your membership fee, everything else is gravy. By the way, I'm cheap enough that when we drove anywhere, we I would look up the possible Costco locations along the way with gas stations and fill up there to save even more. I typically drove 20-30 gallons a week between LA and SD for a few years and I know I saved a lot on gas, way more than the membership. Even then I split the membership with my mom.

But the argument is you spend more in bulk buying and you waste a lot. Not if you don't buy stuff that doesn't perish. Though I love their food deals, the better deals to be had have been on non-food stuff. If you buy their toilet paper, paper towels, paper plates, dishwashing detergent, laundry detergent, you get a better deal on average than regular store shopping. It doesn't beat coupon cutting, BUT that could also be argued because you don't have to waste time couponing. Another place for sure you save is something like Dove bodywash, a bottle is $5 at the store, at costco I've bought a two pack for $6 (with their coupon). Or shampoo. Also both our cars have tires from Costco, I looked online, but with a coupon from Costco it was cheaper than ordering it and putting it on. Plus they have a lifetime warranty where they give you back money depending on the wear. This happened to me and it was awesome. Also if you move, it doesn't matter, they'll honor it at your new Costco.

Another reason for such customer loyalty is Costco's phenomenal return policy. Our tv from last summer broke in May, we went back to Costco, they took it back no questions asked. Then we turned around a bought another tv. It probably got jarred in the move, but they were great. Their customer service is outstanding.

Another money savings is their clothes department. Last summer when DH started his job he had no clothes. So off to Costco we went and pretty much outfitted him for very little money. We got DKNY, Liz Clairborne, Tommy shirts on sale for about $10 each. And we got a few dockers khakis for $20. The one huge downside is you have to be a pretty standard size to fit, good thing DH's a M, 30/32. He's highly amused because he can identify people wearing Costco clothes now (since he owns so many). And we haven't shopped for him since.

Finally it's fun. Strangely enough our best networking has been done at Costco. We see people there from work, or people we see at work but know at Costco. We chat and find common ground in our "thiftness" and love of a deal. Maybe it won't translate into a promotion, but oddly enough it did help DH network to find place to apply for job...and his application was seen.

How does Costco breed such loyalty? Undercutting prices, tailoring the store to the customer base, superior customer service, fantastic deals for people who hate cutting coupons, and making the shopping experience fun.

But does Costco save you money? I guess the answer is up to you...I've been a loyal customer for almost 7 years now, but the bulk of my savings came in the form of gas. Worth it? Yes, I drove close to 2k miles/month and the gas savings of 10 cents/gallon made a huge difference. I'm branded for life a Costco member.

Although I have been considering checking out Sam's Club. But from what I've seen and heard they just don't have the same brazing loyalty or branding...

Do you pass up free money?

Thought I was going to write about a 401k match, NOT! Actually tomorrow is DH's ESPP semi-annual purchase and sale date. I have to go and log in the set price so I know what the stock will price at for the next 6 months, thus I'm contemplating how much we're going to make on our investment today.

What is ESPP? It is employer stock purchase plan. What happens is the company allows employees to purchase company stock at a discounted 15% rate off the set price. The set price typically occurs twice a year, and the employee either gets the stock at the Nov 15th set price or the previous May 15th set price, depending on which is lower. Amazing deal right? Where else can you plunk your money into a savings account for 6 months and earn 15%?

Now there are a few limitations, the first of which is money. DH's company allows us to put in 15% of his salary, which is considerable, but right now we just can't afford it. Did I just write that we can't afford it? Yep, we can't afford to save more. I feel like such a failure to be passing up free money. It really gnaws at me and DH to pass up this free money. I guess if we cut out cable, internet, eating out, and sell the dogs. But I don't think DH will let me fly with that, so 10% savings it is. My stretch goal is to save 15% come February 2007 when DH gets a raise (and prayers a promotion). Then we can stop feeling guilty pangs.

Getting back to the ESPP, sure they give you the 15% but it's not really 15%. It's actually about 10% after taxes? How so? Well say you "churn" the stock on the purchase date. Then you are making 15%, but having held it for only 6 months you will be hit on the earnings portion with short term capital gains. Say you have $3000 but it went up to $3500, you will pay taxes on the $500 of earnings.

The short term gains are unfortunately your normal tax bracket. So by selling today we are in the 25% bracket. Ugh, there we lost $125 immediately to the federal government. Then we lose short term capital gain to state taxes, unfortunately in MA this is 12%, ugh. That means we would lose $60 to MA. This leaves us with...$310, which is about 10% return on our money.

That is still a great deal in my opinion for risk free investing for 6 months guaranteed return! Of course our returns would be greater if we held the stock for 1 year and let it become long term capital gains. In which case the tax rate would be 15% federal and 5.95% MA. But this comes with huge risk that the stock price in 1 year won't fall and become lower than what it is today.

So should we sell or should we wait? Well I'll now lay it out here, we are buying the stock at $28.23 and currently it is $42.69. That means we have made 50% in 6 months. Should we take our profits and run or should we just meander and wait? Why wait? Because typically stocks up at the end of the year. Also we get more stocks on 12/5 so we could save a bit on commission by selling all at one time. This is something I think we'll have to contemplate more.

Why I love my Adjustable Rate Mortgage

Okay so most people say "ugh no way, awful, too risky." I say hold on, it depends on why your getting one and what type of adjustable mortgage. I'm going to discuss the different types of adjustable mortgages, the pros and cons, and why I personally chose an adjustable mortgage.

First an Option-Arm mortgage, which gives you the opportunity to pay as much or as little as you want per month. If you don't pay all the interest it just ballons up and you owe more than the house. Pro, very low monthly payment. Con, obviously you can owe more than your house is worth. Whose it for? People who have variable incomes, and maybe have some lean months, but some great times, so they can pay it off. Great for people who maybe have huge bonus or commission checks. Not great for people stretching to buy a home. Also good for people interested in paying off the home super fast.

Second, Interest-Only Arm, a mortgage where you only the interest on the loan. Here typically you have a set number of year 3,5, or 7 where you only pay the interest on the loan. Then it reamoratizes and you have to pay the pricipal down faster in the remaining years along with potentially the higher rate at the new adjustment. Pros again low monthly payment. Cons, if housing prices go down, you've built no equity up to cushion yourself. You could owe more than the home is worth. This is mostly for times when homes are going up, if it's going down, you may not have a valuable asset at the end. So it's probably for people who like risk, are going to move or have an increase income soon, and the market is going up instead of down.

Finally the typical adjustable rate mortgage, where it stays fixed for 1, 3, 5, 7, or 10 year, then adjusts annually afterwards. Typically your mortgage is amortized from the beginning, and there is an annual and lifetime cap on rate increases, usually 2% annually and 5% lifetime. Pros, good for people who expect more income, want to move, or plan on paying it off in this fixed time period. Cons, you could end up with a high rate and owing a lot more later.

We went with the typical adjustable rate mortage for a 7 year fixed period. I love our rate 4.25% with a lifetime cap of 5%, so the most we'll ever pay is 9.25% if we stayed here forever. Now what that means we will owe after 7 years approximately $400k on our home if we made minimal payments. Then if it adjusts to 9.25% our payments will go from $2263 to $3504, more likely the rate will be 7.25% so our mortgage will be $2982. If we had done the 30 year fixed for 6% the payment would have been $2757.

Now, look at that, our rate at the absolute highest will be only $750/month more than the fixed rate. Is that a big deal, in 7 years I don't think so. Would it be a big deal now, not really. Could we manage it? Yes. Chances are we'll still pay less overall because of the lifetime cap when compared to the 30 year fixed.

Why'd we choose the ARM then? Was it for the lowest payment? Yes. But we had other factors such as we knew we'd have an increase in income before then. One DH just got a job so his salary now is not where it will be in 7 years. Two, I'm in school so my income isn't close to where it will be in 7 years. What if your a SAHM though? I don't make much now, we're not using my income to live on really so no big difference there. And DH's income is still going up because he's also in school part-time for another degree (what can I say, we're addicted to degrees). So I think the likelyhood of our income increasing is close to 100%.

Second, we don't love our home enough to live here forever. Hey we live in the NE in a super expensive area, we bought a townhouse (3 bd/2.5ba with connecting walls). Ugh, no we want to live one day in a single family home. I forsee when we finish with school moving again, probably within 7 years. Also everyone knows we hate it out here, we're moving back to the West Coast as soon as school is done.

With those 3 reasons in mind, we knew that we were in a position to financially buy a home with an ARM.

But what if we want to keep the home and rent it out? No we aren't the landlording type, or else we would have kept our cheap place in SD. No we need the equity probably for our next place.

Finally our home is not an investment, it's just a nice place to live without moving. So if we don't earn much on it in the next 5-7 years, it's okay. This way we're paying minimal interest to borrow money for a very slowly appreciating asset. And we're minimizing our potential losses, while maximizing our retirement and taxable accounts with cash in hand. Homes still are ill-liquid assets.

Paying off a mortgage early...or not?

Should you get a 15 or 30 year mortgage? I personally feel a 30 year because you can always pay it as a 15 year if you choose, yet are not bound into higher payments if you lose your job or any emergency should arise.

Now should you pay off the mortgage faster than either 15 or 30 years? I say yes, but only if you are already maxing out your retirement savings, have a comfortable cushion on savings for new cars, maintenance of the house/cars, vacations, college savings, and any other expenses.

Now why? Because as long you are disciplined and save the excess in say a 401k or Roth IRA then you are making more than your current 6% mortgage rate. Now to max out your retirement you should be saving $19k/year. If you follow Dave Ramsey's 15% rule, that means you need to be making $126k/year.

So my philosophy is this, instead of paying off the mortgage, max out the 401k and Roth IRA and take advantage of the tax break. You also get a tax break on the mortgage, but that's not a reason to keep it. Keeping it for investment purposes will help because when you retire, you need to generate enough income to throw off the property taxes you may owe when you retire. Those never go away, only the mortgage.

Now if you are in the 15% federal tax bracket, by investing in a 401k, you area already deferring an extra 9% on your mortgage, and you have compounding returns on your investment. So you are coming out way ahead by saving in a 401k.

You reply, I'll have my mortgage payment to invest if I pay off the house. Sure you will, but you can not go back to 2006 and max out your 401k. You will be forced to invest in a taxable account where you will pay taxes on your interest/dividends going forward. That means less compounding.

"But I'll catch up.." No you won't if you saw my earlier post on how much a difference 5-10 years can make on compound investing for retirement, you'll never catch up. Especially if I've been saving in a 401k and Roth IRA. You will also save in 401k and Roth IRA, but also be forced to save in a taxable account the overage. I'll have extra money in my account because I won't have to pay on my returns every year like you will on your taxable account, so the Roth and 401k always grow faster.

I will also at this time be keeping my mortgage with it's tax break. For myself personally it's a 28% write off on a family that's double income no kids. The break is substantial. Plus we're maxing out our retirement accounts, and in the future I'm going to divert the rest to college savings. I guess I should add our mortgage is so large that we pay $20k in interest alone a year, way above the standard deduction. But we keep it because we feel that saving the maximum in retirement accounts more important.

It is mostly about risk, but I see very little risk involved with investing in a 401k or Roth IRA where your tax break outweighs a 6% fixed rate mortgage.

So should you personally pay off the house? I don't know, there are a lot of factors involved. But a good rule of thumb would be no, if you haven't saved $19k/annually per person a year into a retirement account. Otherwise, sure go crazy and pay it off.

Is college savings worth it?

Dave Ramsey's step 5 is to save for college. He doesn't give any numbers or suggestions other than save what you can. Now is this reasonable? I don't think it gives enough guidance.

Now using a simulator saving $2k/year for 18 years @ a rate of 8% return will give you $77,123 for your child's education assuming you start when they are born. That sounds great, but will college really be only $77k? I don't know, but probably not.

But the real question is should you be saving more? I say maybe. You should only be saving more if you have already maxed out your 401k, Roth IRA options, then yes definitely save more. If you haven't saved $38k/year, then save the $2k/year and go back and put the rest to retirement. Trust me, you kids would rather have school loans than have to try to support you the rest of their lives during retirement.

Besides if you take out loans for your kid, you can always pay them off after college if they finish with good grades in four years. But if they drop out then you haven't wasted any more on something they don't appreciate.

Our personal goal is to save $10k by our kid's 1st birthday. I have no idea if this is a strech goal or not, but if we can put that away I think we may not need to save much more. Currently we have saved about $500.

How to live on 15%...

Following my series on Dave Ramsey, is 15% enough to save for retirement? There are many factors which weigh into this calculation. First your age, if you are 25 then probably. If you are 45, I have my doubts. Second, do you have anything saved and if so how much? If you are 45 with ZERO start worrying. If you are 25 and have zero, well save faster. Third will you have a defined benefit plan (pension) where your company will pay you a set amount every month? This could offset not having as much cash saved for retirement. Of course with companies like United, Enron, Ford, etc all cutting their pensions, if it's with a private company I don't know how much I would count on getting the full benefit. Finally it depends on when you want to retire, for sure 15% is not enough if you want to retire earlier than 65 even if your 25. You will need to cover your medical and any other health issues before 65 when medicare kicks in.

Now to address specifically if 15% is enough. With two people working, you are allowed to save $4k/annually for a Roth IRA and $15k/annually into a 401k. This equals $38k/year into tax deferred retirement accounts. So for our calculations we'll be putting everything into a tax deferred or non-taxable account.

Consider if you are 45 years old with no savings, well every $1 million dollars in savings = $40k/year living. This assumes you withdraw 4% which is the amount estimated by all economists to not outlive your portfolio. If you are making $60k/annually you need a $1.5 million porfolio to replace your income without Social Security. But let's assume you will get 20k/year from SS at 65, and will retire at 65 (full retirement age is actually 67).

So you need $1 million in today's dollars and you have 20 years. If you save 15% of $60k that's $9k/year into a Roth/401k. Assuming an 8% return on investment (DR says 12% he's seriously crazy), you will have $425,800. That's 50% less than you need to generate your income for the rest of your life. According to the MSN calculator you should be saing $21,137/annually into your 401k/Roth IRA for 25 years to reach $1.25 million. That means you should be saving 35.2% of your gross income.

So how do you live on Dave Ramsey's fictional 15% savings? Well his 12% earnings sound real good about now. But it's not going to happen, and if you follow his investment advice you could lose big (25% aggressive growth, 25% growth, 25% small cap, and 25% international). Where are the bonds? Also I'm guessing he's assuming a lower standard of living when you retire, not necessarily true if you are unhealthy or want to travel. Medicare doesn't cover a lot of things, so perhaps replacing 100% of your income is not unrealistic.

Let's run the numbers again if you are 25 and 35 years old. But this time these people get no SS so they need a $1.5 million portfolio, assuming 8% returns. The 25 y.o saving $9k/annually will have $2.5 million saved for retirement. To save only $1.5 million he will need to only save $5349/annually or 8.9% for 40 years. Of course not many 25 y.o make $60k.

Now the 35 y.o saving for 30 years will have $1.077 million saved, enough to have a slightly cut back lifestyle. Now he only needs to save $12,530/annually or 20.8% of his $60k salary to reach $1.5 million for 30 years.

So it appears if you have a longer time frame you are able to meet DR's goals of 15% savings. It's also assuming that the 25/35 year old is making $60k (not peaking out at $60k) and can easily save 15% on top of saving for a DP for a mortgage or is already carrying a mortgage. Another issue is that I assumed SS wouldn't be available for these younger people, is that correct? Maybe/maybe not, but I would use SS as icing on the cake, not supplemental income. A lot of reform is coming on both Medicare and SS so I don't see it being a guaranteed income. Another issue is saving for college if you delayed having kids or have lots of children. This will be addressed in another column.

So the moral of 15%? It's enough if you are young and make a good income. It's not enough if you are older and don't have much saved. Rules of thumb are typically more applicable the younger you are, the older you are the more you need to rachet up that savings. And 15% is great if you were saving nothing before.

Questioning Dave Ramsey's Baby Steps 2 and 3...

Regarding Dave Ramsey's baby step 2, yes the math doesn't make sense. But the idea isn't to quickly pay off debt, it's to change you behavior and learn to not use credit cards and more importantly live below your means. Changing your behavior is the toughest part of financial responsibility.

Now first my issue with stopping retirement contribution. Yes you do need to be focused, however if you are going to be on BS2 for longer than 24 months then even DR says you probably need a larger than $1000 baby EF and you shouldn't stop retirement contributions at least up to the company match in the 401k. This is because Murphy's Law is more likely to occur the longer you go without a Emergency Fund. Now I think that passing over the 100% match from the company in the 401k is a bad idea no matter how long you are in BS2. It's a guaranteed 100% return on investment, so I think it's worth delaying BS2 by one month or two to get it. But this is personal finance and it's up to you.

My bigger issue with BS3, is that DR doesn't give enough attention to what a emergency fund should encompass. Some people feel it encompasses anything like car replacement, home maintanence, etc. I however feel that the EF should only be for death, surgery, and job loss. Everything else should be covered by it's own sink or replacement fund. What does this mean?

This means that you should get 3 months of expenses in place, then start sink fund, then go back and finish up your EF to 6 months. Now what are sinking fund? Stuff like car repairs, vacations, property taxes, car insurance, home maintanence, gifts, christmas, birthdays, furniture, pet fund (if pet is old), stuff that can go wrong and yet aren't sure how much but you want to be prepared. I don't think a car breaking down is an emergency, instead you knew your car is old and either you are saving to replace it or you are saving to repair it. I think you should determine how much you need to replace it (because no car lasts forever), then save that monthly. Same thing with a house, you should be saving 1% of your home value for annual maintanence.

But people really get excited with retirement, and ESPECIALLY paying off the house they forget about proper care and maintanence. Sure it's great, but what if when you are rushing through some steps you car breaks? Do you really want to forever drive a hoopty? I don't think DR puts enough emphasis on how and EF is for true emergencies and everything else needs to be budgeted for.

My final issue with steps 2 and 3, is that I think buying a home should come after step 4. You should fund retirement and get an idea of what it feels like to minimally save 15% before you commit to a mortgage. That way you don't get into more debt than you can handle. I see some people paying off debt, buying a home, yet struggling with 15% retirement. It's likely they didn't realize how tough it can be. However I do agree with DR, that it's great to buy a home with 20% down to avoid PMI, and you should try to stay within the 25% PITI guidelines. Just because the bank offers you a loan, doesn't mean you can really afford it.

As far as steps 4, 5, and 6, I'll discuss that in depth tomorrow.

Dave Ramsey's Baby Steps Explained for Free

I actually really like Dave Ramsey (DR) and think his get out of debt method works and makes sense. However I find it greatly ironic that people who are in debt will pay money to him to get out of debt. It seems almost counterintuitive. But he's making a lot of money, people are happy and getting out of debt so whose to complain? But if you are serious about getting out of debt and are a cheapskate trying hard, I'm going explain his steps to you for free.

Pre-baby step 1: Cut up all Credit Cards and draw a line in the sand, NO MORE DEBT!
-At this point, concentrate on getting current on all bills (rent, CC, car payment, utilities)
-Build a bare bones budget starting with the 4 walls (home, food, utilies, health), then determine what are absolute essentials and what are not.

Baby Step 1: Build a baby Emergency Fund of $1000.
-Because you've cut up the CC, this is to prevent more debt from occuring when setbacks or unexpected expenses occur. You may sell stuff off to get this, you might get a second job. The objective is to get a cash cushion as soon as possible.

Baby Step 2: Get out of Debt!
-DR says to pay off debt smallest to largest. Why? Because you are changing behavior and it's easier to stick with the plan if you see small accomplishments along the way. Yes it makes more financial sense to pay off the highest % rate debt, but if you understood finances you wouldn't be here reading about DR, would you?
-Snowball your debt. What that means is pay the minimums on every debt owed, then use your leftover money to pay off the smallest debt. Example you owe $300, $800, $2000 with $10 minimums each. You have $100 to pay off debt, you pay $10, $10, $10, and add the $70 to the $300 debt. That should be paid off in 4 months, then you can take the $10 minimum and $70 extra and throw it to the $800 debt. Got it?
-My main issue with BS2 is that DR says to stop all retirement contributions, something I disagree with and will discuss tomorrow.

Baby Step 3: Fully Funded Emergency Fund (FEFF)
-DR says to put into a liquid account 3-6 months of your expenses. This can be at ING, HSBC, etc. Just somewhere in case of emergency pay it off.
-Now tomorrow I will discuss my issues with DR starting with this FEFF and his lack of details regarding what is an emergency.

Baby Step 3b: Saving for a home.
-DR says to buy a home with 20% DP minimally, 15 year mortgage at no more than 25% of your net take home.
-Again here I disagree, this should wait until after you do your 15% retirement because I think you should base your purchase off your income after you account for saving for retirement. I also think a 30 year fixed can be appropriate or an ARM (I'm writing a column why I love my ARM).
-Also I think that 15 year fixed is more risky than a 30 year because a 30 year can always be paid like a 15 year if you choose to.

Baby Step 4: Save 15% of gross income for Retirement
-DR prioritizes correctly 401k match, Roth IRA, and then back to the 401k.
-He suggest 25% aggressive growth, 25% growth, 25% small cap, 25% international
-I have serious issues with how much he reccomends to save and the fact he does not include bonds in his portfolio asset allocation. He doesn't have a clue what he's talking about and this will be discussed in depth in another post.
-I guess I should add I really like DR for up to Step 2, but after that I have some issues with his common sense.

Baby Step 5: Save for college
-He does not give any numbers for this, because it's personal finance. Great in principal, but realisitically I think there needs to be more guidance and more focus on retirement savings before college. After all the people using him were in debt.
-We'll discuss this in another column as I debate how much to save for my unborn kids.

Baby Step 6: Pay off the house
-If everything else is going well, you have more money and have no desires, pay off the house asap. DR says who need the tax break.
-Do I agree? Yes in principal, but I'm an ultraconservative money hawk. I am the type of person to have all possible scenarios funded like car breaking, vacation, emergency visit home funded, all retirement savings maxed out, all college savings done before paying off the house.
-Why? Mainly because the house is an ill-liquid asset, and right now potentially a depreciating one. So why pay for something you may need cash for?
-DR says everything else should be properly taken care of first, so I guess we agree.
-A lot of die hard followers pay off the mortgage without funding any "sink" funds or go "gazelle." I personally like a little nicer life and can live with a mortgage, though it probably will be paid off when we retire.
-Guess I'll discuss later why to pay off or not your mortgage early. Main argument, better investment wise to not pay it off, but pay it off early if you were the type of person in debt because you probably aren't money savvy.

Baby Step 7: Live Like No One Else
-give, donate, spend on stuff you always wanted because your free.
-I think a lot of people don't know how to spend at this point because they've been so gazelle. But maybe I'm wrong. I enjoy life now so I can't really see increasing my happiness much more than it is now. It's quite luxurious, although if I did have more money I could have a newer car, more expensive type vacations, and go home more...hmmm...

How to maximize Reward Credit Cards

By now you've realized I'm a major cheapskate, I love a great deal. And I'm a major CC user who to quote nervous from Your Money on MSN, "they'll have to pry my CC out of my cold hands." I thought his quote highly amusing. I'm going to write this today and tomorrow follow up with Dave Ramsey's Baby Steps for getting out of debt, because I believe in it. We are not your typical CC user, neither DH or I have ever paid a penny of interest or paid a late fee on any accounts since we were 14. So we've had CC for more than half our lives and haven't misused it ever. When I was young my mom said to use the CC like a check book, every expense had to be tracked against what I had in checking to see if I could really afford it.

But for now I'll explain our current credit card strategy and how much we've earned in rewards this year. If I took the time I know we've saved thousands of dollars over the years in cash back rewards, how do I know? Because when you are two grad students living in San Diego, who can afford to buy a condo with a gross salary of $40k, you are a thrifty penny pincher.

First we typically use our Citibank Simplicity card for everything. It gives us 5% cash back on all gas station and drug stores purchases, and 1% back on everything else. The maximum cash back reward is $300/calendar year. Another bonus is no late fees, never had one, but I thought it was a nice benefit. We autopay everything so nothing is ever late or not paid in full. We got it back in April, but have earned so far $91 this year. Not bad just for using the card. It would have been more, but our other credit cards upped their rewards so we've been using them more. Plus we had an Alaska Airlines card until July. I do not like airline miles typically, but this deal was too good to pass up, I'll explain later.

Second card we use is the American Express True Earnings Card. We picked this card mainly because it works at Costco, where we are die-hard members. Now with the true earnings card you get 3% cash back at eating out anywhere, 2% cash back from any travel related expenses, and 1% cash back on everything else. Great deal, so we've started to use it for eating out and as always costco shopping. I am also planning on buying DH's ticket home for christmas on it, I already bought mine on it for 2% back extra online. This year we've earned $44 in rewards.

Finally we started this summer using Discover card for stuff. 4x a year they have this get more back program where you get 5% back on specific categories. This summer it was school supplies until Sept 30th, and this current quarter it's shopping and eating out. You also get 1% back on everything else on the card. So I paid for DH's tuition and my stupid school stuff on it and wow! Since June our cashback bonus this year is $142. So that pretty much sums up our regular use cards.

Do we have store cards? Yes, three actually that we somewhat use. Gap because every $250 spent you get $10 gift certificate and special coupons in the mail. I shop for me occasionally, it adds up over the years. Home Depot is a huge one we use, I get a 10% off in the mail, then put it on the card for 0% APR 1 year. We did it about 3 times buying stuff like cabinets for our condo in SD, paint, curtains, etc. Sometimes we've forgotten the card and paid on another one so no biggie, but it's a nice bonus. Another great thing is I've negotiated an extra 10% back when I was unhappy with our cabinet order taking so long and saying I was a loyal customer ie CC. Finally we also occasionally use the Best Buy CC. We used it initially in SD to buy a washer and dryer and get 10% when we opened the card. It saved us about $70 at the time, and then when we moved we had to buy another washer/dryer so we just went there. The great thing is we got 24 months 0%, plus tax free day, plus I negotiated free delivery as BB card holders explaining again we're loyal customers. All in all I typically don't like using store cards unless it's somewhere we're going again and these places we've always gone back to.

Finally I want to discuss airline cards. They can be great if you travel a lot and use the same airline. My mom and DH's best friend both have airline cards and adore them. But we don't travel enough, or with enough loyalty to make it worth it. This past year however Aug 2005-2006 we did have an Alaska Airlines card. Because when we got our mortgage they offered us a deal to get 100k free miles if we opened the card and paid for 1 year annual fee. That 100k miles is 3 free round trip tickets, so we figured why not pay $75 for the annual fee. We then decided we would max out usage on the card for the year we paid for and then cancel it. We did exactly that and now on Alaska Airlines have about 120k miles in DH's account. It's not a bad airline for us because DH is from Canada so using it isn't as big a deal as for other people.

That about sums up my experiences with reward and store credit cards. Guess you can see why they'll have to pry it out of my cold hands...but seriously CC are not for everyone, nor should they be used to live a lifestyle you cannot afford in cash. They are just a tool for cheapskates like me who need to squeeze a penny out of everything. I like looking at my itemized statement, I can easily reconcile it with our budget, and I enjoy seeing how much I've made back. Maybe CC don't make you rich, but in my experience people who use CC responsibly are the type of people who max out their retirement accounts, save for a rainy, and in general very conscious about how they spend money. So it doesn't make you rich, but maybe it's a sign of how diligent you are about your money.

Any opposing views, or people in agreement should feel free to comment.

Car Loans versus CC debt

Okay so over at LLNOE, I asked the question why do people seem to think that car loans are not as bad a debt as Credit Card Debt? It had come up on another board that people can easily classify CC debt as bad, but car loan debt is justified. Yet car loan debt is 3x as much national average (approximately $24k) versus the average CC debt of $8k. This to me seems to say that people are buying way more cars than spending it on foolish things.

Does buying a new/used expensive drive CC debt? Is it having the expensive car that causes someone to use CC and fall into a vicious cycle of debt? Or is it the rolling over of car loan into car loan that you are "upside" down the real reason? It's a tough call.

But consider this, it's a lot easier to hide your CC debt in the stuff you buy, yet people will probably wonder how does this guy afford a BMW on his salary? The explanation he leased or took out a car loan. But how many people really have car loans versus having CC?

It has been stated 25% of people out there do not have CC, 30% pay it off in full every month so 55% of the population do not carry CC interest. The remaining 45% have an average of $8k in debt. However when looking at the statistics of car loans 3 out of 10 are upside down in their vehicles, average car loan is $25k, and 40% of buyers have loans greater than 60 months.

So where does this put us as a society? I have no idea if we'll have a car loan again, we had one initially when DH bought a car, 3 years 0% to build credit after arriving in the states with no credit. He decided to pocket the money and build credit, and keep more cash on hand. Turns out a better deal all around. But now we're not so sure, but of course it really depends on when we need a new car.

However this was eye opening enough for me to determine I have to really plan for the future of my cars.

Buying airline tickets

I always hassle with trying to buy airline tickets for a good price. Mostly because I'm always trying to make someone else happy. I got a great deal for hawaii at Christmas by flying somewhat awkward days of 19th to the 28th. But it was around $600, which is dirt cheap. Before when I've flown home from the West Coast to Hawaii it's cost me that much anyway. Part of the problem for me at least is living on an outer island which substantially increases the premium of going home. That and the layover to catch another flight.

Now going to Canada unfortunately is also very expensive. DH's trying to book his ticket, or rather I am booking his ticket, but it's becoming a very expensive. Can you believe he'll pay nearly as much to go to Canada as I will pay to go to Hawaii? This Christmas is turning into a way more expensive proposition than I ever expected.

Of course I had no idea that my mom would need surgery so I can't say that it's a planned for expense. But I am going to tell DH to keep the spending to a minimal. It's ridiculous to be blowing money right now we're both really broke, the majority of which is coming from trying to pay for his ridiculously expensive private school MBA. That is definitely another blog and rant about the cost of a private school.

But back to tickets, ever wonder what the person sitting next to you paid for their ticket? Ever wonder how much it cost them? Ever wonder if you got the short end of the stick? There should be a way to determine how much a ticket should be. But the airlines love to keep us guessing, before they would drop prices at the last minute and still do, but the truth is that many people, ourselves included cannot arrange vacation time last minute. So the vicious cycle ensues where you try to constantly get the best price.

Perhaps this is what it means to be financially free, to be able to buy any ticket at any time no matter what the cost. Where cost doesn't matter, but time does.

Are Credit Cards to Blame?

I guess I should start with my first rant about whether or not credit cards are really to blame for the debt people are in. I think no, but I am willing to hear other sides of the argument. My viewpoint is that people create debt, be it credit cards, mortgages, car loans, student loans or what not. But it should be personal responsibility that decides how much to borrow.

That being said, no one is holding a gun to someone's head and saying spend, spend, spend on the credit card. No one is telling someone if they don't buy the item they will die. It's a personal decision that you must have someone you cannot afford. How do I know you can't afford it? Well then you would be able to pay for it either in cash or in full when the credit card bill comes. I think it's the mentality that buying stuff on the credit card isn't cash. To me, how I was raised and have always thought about it is that whether you purchase it with cash or credit, it's still money you already spent so stop spending if you haven't got it. I luckily married a guy who feels the same way.

I don't understand how people say they didn't understand how credit cards work. Did people grow up in cave? Does the idea that you have to pay for what you charged seem outrageous? Or is it more likely that what you bought should pay for? It's a really strange thing occurring where people blame lack of financial knowledge, yet have used CC for 10+ years. They never felt like waking up before?

But I have to also say that some people can't keep credit cards because they are unable to manage their finances properly. And for those people the temptation will always be to great. My grandfather is one of those people, and probably the sole reason why everyone in my family is anti-debt, but not anti credit card. Everyone uses it, but to imagine owning after what they all went through. No way!

But for everyone in debt try finding Dave Ramsey. I will post on his baby steps which I think are great for people who are terrible with money, in debt, and need some serious straightening out. I also like Suze Orman, Mary Hunt, and a few others.

Turning 30...

I want to write about where I'd like to be at 30, that's a few years away so I've got time. First and probably the easiest goal is to have a baby. I want to have a baby by the age of thirty. Not a big deal.

Second, I'd like to have $150k in retirement accounts, considering we start June 2005 with a big fat zero, I think that's a good goal. Now to follow DH's company example, I'll put a stretch goal, $200k. That is if our investment portfolio does really well because there is a contribution limit of $15k/year 401k and $4k/year Roth IRA which we are currently maxing out.

Third, I'd to have $100k in our taxable accounts, I am guessing that we may be close to this number depending on when we buy our next car. This goal is easily achievable if we don't purchase a new car, and nothing happens to our older ones.

But of course, right now as I type this our 2000 Ford Focus is having issues. That is probably the next posting, whether to buy use or new, and foreign versus american. Our stretch goal is going to be $200k in taxable accounts. That puts at close to a net worth of $500k by my 30th birthday. I think that if we reached that goal, it would be amazing.

As it now stands we have a networth of $182k, most of it is home equity in the form of a down payment and paying down the mortgage. That probably should be another post, why we bought and used an ARM mortgage.

Fourth, I'd love to graduate, but then I should get off the computer and get back to work.

my first blog

Okay, so I'm new at this blogging though I read other people's blogs and comments. I also have tried blogging on myspace, but I really want to do a blog about finances and things in general. I am not sure how this will work, but I have to start somewhere.

So I'm a twenty something married woman in the northeast, still in graduate school. I enjoy thinking about all things financial and find it gives respite from the boredom of work. I also enjoy the idea of having enough financial freedom one day to do nothing, or at least something really cool. If you know me, you know that I'd enjoy being my own boss one day, maybe own a bookstore.

My DH on the other hand dreams of being a business man as well. Currently his dream is to own a doggie daycare/boarding facility and franchise it out. If we have enough money to subsidize this dream it may one day become a reality.

So how if we have these big dreams, then why are we both boring scientists? Why do we work 9-5 jobs? Because truth is that we need it to pay the bills. We have all these dreams, but no funding for it per se. But if we keep on living almost large, then perhaps one day we really can live large...